Intro
Some people use credit cards a ton, and others avoid it like the plague.
There's a ton of conflicting advice in personal finance circles, from people like
Dave Ramsey who advise to never use credit cards, others like The Money Guy
recommends using credit cards responsibly, and then there's the churning community
who tend to use credit cards a ton.
This post will go over how credit cards work, commmon benefits, and will conclude
with general advice on what "use credit cards responsibly" means.
Statement cycles, grace period, and interest
Bank accounts usually operate on a monchly schedule, where you'll earn interest on
the average balance throughout the month. Credit cards operate on a statement cycle.
Most credit cards use a month-long statement cycle, so your statements will close on
about the same day each month, whereas some use a fixed number of days in the statement,
so your statement cycle can "drift" month to month since months aren't the same length.
The larger issuers tend to use a month duration, so your statement will usually close
on the same day each month. Credit card payments are usually due a fixed number of days
after the statement closes.
A statement cycle contains all of the transactions that happened during that time.
The sum of all of these transactions is your statement balance, and after your
statement cycle closes, your total balance (the number reported on the website) will
include any transactions you made after the statement cycle closes.
Grace period
The time from the purchase to the due date after the next statement close is called
the "grace period," which is the period where interest does not accrue.
Here's a simple example:
- statement opens on the 10th and closes on the 9th of the following month
- payment is due 16 days after the statement close, so the 25th of the following month
Anything you buy from the 10th to 9th of the next month will be part of the same
statement, and those purchases will not accrue any interest until after the payment
due date, the 25th of the next month. So if you buy something on the 10th, you'll have 45
days to pay that back before that purchase starts accruing interest.
Minimum payment
Credit card companies require making at least the minimum payment every month in
order to be on time. Usually this is the larger of a fixed amount (e.g. $50) and a
percentage of the amount owed on the card (e.g. 1% + interest). If you make at least
the minimum payment each month, your card will report to the credit bureaus that you
paid your bill on time, which will help your credit score.
However, if you pay less than your statement balance, the remainder will start to accrue
interest daily, and that interest will be added to the total for the next month's minimum
payment.
Interest calculation
Let's say you have a credit card with these figures:
- $50 minimum payment, or 1% of total balance + interest accrued, whichever is greater
- 20% interest rate
- $10k balance
Let's say you make the minimum payment. In this case, 1% of $10k is $100, so your minimum
payment would be $100. Since no interest has accrued yet, all $100 of that payment would go
toward the balance, and you'd start accruing interest immediately. The first day after your
payment due date, you would accrue:
$9,900 * (20% / 365) = $5.42
The next day we add that interest to calculate the next day's interest, which is:
$9,905.42 * (20% / 365) = $5.43
And so on. If there are 30 days in the month, that's going to be $165.70 in interest added
on to your balance, which is greater than your initial 1% minimum payment.
Your next month's minimum payment will be even higher because you'll be required to pay
the interest plus that 1% toward the debt, so the new payment will be ~$265.70.
Different credit cards have different rules for the minimum payment, but in most areas,
credit card companies are required to have the minimum be high enough that if you stop
making any more purchases, you'll eventually pay off the debt by making that minimum
payment.
Avoiding interest
As long as you pay your complete statement balance by the due date every month,
you will never pay any interest.
Most credit card companies offer autopay that lets you choose between the minimum payment,
your statement balance, and your total balance. The total balance includes transactions in
the next statement cycle, and you do not need to pay those until the next statement closes.
Setting autopay to pay the statement balance is sufficient to avoid paying interest
indefinitely, provided you always have enough money in the account used for autopay.
Common benefits/card features
Foreign transaction fees
Both debit and credit cards charge a fee for making purchases outside of your economic
zone. In the US, that means any other country, whereas in Europe, purchases within the
EU probably don't incur a foreign transaction fee.
Most travel cards have no foreign transaction fee, whereas most no-annual fee cards do
charge that foreign transaction fee.
Just note that this depends on where the payment was processed, not where the purchaser
is, so purchasing from some websites can incur a foreign transaction fee (i.e. I get charged
one for purchases at Fanatical.com, despite prices being listed in USD).
These fees are usually a separate line item in your statement, so you can check if a
fee was charged.
Extended warranty
Many cards will offer to extend the manufacturer's warranty if you make the purchase with
the credit card. For example, the Costco Visa credit card extends any warranty by 1 year,
so if the device within a year after the manufacturer's warranty expires, you can submit a
claim and the credit card company will reimburse you for the cost of the purchase according
to their terms.
Rental insurance
If you book a rental car with the credit card, the credit card can serve as auto insurance, meaning
you can avoid getting the insurance through the rental company. This benefit seems to be
disappearing, and the terms can be a bit nuanced, so definitely read up on the details if you
are considering relying on your credit card's rental insurance.
Price protection
If the price of a product drops within some window of time after purchase,
your credit card company may reimburse you the difference.
They usually require you to go through the merchant first if the
merchant also offers similar protection.
Fraud protection
All credit card companies offer robust fraud protection where you are not liable for any
unauthorized purchases. Some fraud department can be more difficult to work with than others,
but in general, credit card fraud departments resolve cases faster than checking/savings accounts.
Impact on credit score
This certainly can vary by country and perhaps credit bureau, but in general, only the following
impact your credit score:
- on-time, late, and missed payments
- age of accounts
- number of accounts (more is better)
- percentage of credit limit used
Whether you pay interest does not impact your credit score in any way.
Getting a new credit card will hurt in two ways:
- adds an inquiry to your credit; hit is small until you have multiple (i.e. >2 and you'll get bigger hits)
- adds a new, young account, which reduces the average age of your accounts
Those impacts usually go away in 6-24 months, depending on the rest of your credit profile.
General advice
Assuming you're responsible, in rough order of importance:
- never spend more than you have available in your bank account (i.e. treat it like a debit card)
- pay statement balance on time every month
- keep your oldest card open
- have at least two credit cards
- increase credit limit until your regular spending is a small percent of total limit
I shoot for keeping my credit utilization under 30% for any individual card,
and under 10% across all cards. This seems to
If you have a history of being irresponsible with credit, or you think you may misuse it,
it's not worth getting a credit card. You can instead use a secured card, or perhaps a
charge card, since both will prevent your from getting into trouble with carrying a balance,
while still reporting to the credit bureaus.
Conclusion
Credit cards can be an incredibly useful tool, provided you're responsible with them.
Read up on the benefits for cards you have, and consider choosing new cards based on benefits you want and need.
