The Ultimate Guide to Credit Cards

Everything you need to know about credit cards before you open one, written by a team of 20 somethings who get that talking money and finance can be hard. Read the whole thing, skip to the part you have questions about, or share with someone who could find this useful. We’re here to make sure you get your questions answered so you can open your first card with confidence!

Everything you need to know about credit cards before you open one, written by a team of 20 somethings who get that talking money and finance can be hard. Read the whole thing, skip to the part you have questions about, or share with someone who could find this useful. We’re here to make sure you get your questions answered so you can open your first card with confidence! 

DISCLAIMER
We are not here to provide financial services. This article is strictly for educational purposes. If you have any questions regarding your personal finances or assets, please consult a professional before making any financial decisions.

The Simple Summary
A credit card is a way to buy things without taking money out of your bank account immediately (a type of loan). Instead, you’ll probably pay once a month for what you’ve bought. If you don’t pay this bill, you’ll be charged interest (the cost of your loan). 

People get credit cards to improve their chances of getting better loans in the future. If you get a credit card and pay the bills off on time, banks see that you’re a responsible borrower (a good credit score) and give you cheaper loans in the future (like a mortgage when you buy a house). People also get credit cards for the rewards like cash-back and airline miles. 


How do credit cards work?
The simplest way to think of a credit card is as a type of short term loan. When you apply for a credit card and open a credit account, your credit card company gives you a set credit limit (for example, $5,000). That’s the amount of money the credit card company allows you to use. You can use a credit card to make purchases, pay bills, and in some cases, get cash. 

Whenever your credit card is used, your available credit is reduced as you charge things to the card. You pay back what you spent with your credit card to the credit card company. People generally pay their credit card bill once a month, the usual amount of time before interest is charged to your remaining balance. 

Interest is the cost of taking out a loan; in this case, the amount of money you’re charged for using your credit card if you don’t pay what you owe each month. 

This one-month period before interest is charged is known as a grace period – the time between when the card is used to purchase something and the due date listed on your credit statement. During this grace period, if you pay your bill in full by the due date, no interest charges are applied.

Your card may be charged interest if you carry a balance month to month, meaning you don’t pay it off completely by the due date on your statement. Your credit card's annual percentage rate or APR reflects the cost of carrying a balance on a yearly basis. Your APR may include both your interest rate and other costs, such as annual fees if your card has those. 

Most credit cards have a variable APR that's tied to the Prime Rate. This means your card's APR can change over time, though the CARD Act of 2009 sets strict guidelines on when credit card companies can and can't raise your rate. Being 60 days late on making payments to your credit card can trigger a penalty APR, which can approach the 30% range. However, the average APR for most credit cards is somewhere in the 20-28% range. 

Let’s break that down a bit: Let’s say you have a credit card with a 24% APR, which is pretty common. That 24% is what you’ll be changed over 12 months, which comes down to 2% APR a month, or 0.065% per day, also known as your daily periodic rate (DPR). If you make a purchase on your credit card and decide to not pay it back before the due date on your statement, you won’t be charged a 24% interest rate on it immediately. Instead, you’re likely to see that 2% interest rate applied. 

What’s important to note is the snowball effect of continually not paying off your credit card within the grace period. When that happens, all these small interest percentages compound to create large interest amounts you then have to pay back on top of your principal, the money you initially spent.

chart showing how debt snowballs over time annual APR and monthly interest rate



How is it different from a debit card? 
As we’ve mentioned, a credit card gives you access to a line of credit issued by a bank, that you get to use and payback monthly. A debit card gives you access to the money that lives in the bank account of the cardholder, where wages and income are deposited. While you get charged an interest fee for not paying your credit card off in time, debit cards may charge you an overdraft fee when your account hits zero, or you have no money left to spend in your bank account. 
 
Basically, the credit card is linked to the bank’s money that you have been given permission to use, while a debit card is linked to a bank account with money you have on hand. Debit cards usually don’t come with rewards, while credit cards often come with perks like getting a portion of your purchase back with points or cash-back. 
 
Tell me more about these perks!
Incentives
Cash-back happens when you get a percentage of money returned to you when you make a purchase with a credit card. For example, your credit card could offer 1% cash-back at all grocery stores. If you spend $100 at a grocery store with your credit card, you would receive $1 back. Cash-back can add up, leaving you with a substantial amount of money over time, which you can later transfer to your bank account and spent freely. 

Another popular perk is air travel miles. This means you are rewarded a certain amount of miles with a certain airline your credit card has partnered with for each purchase you make. For example, your credit card could offer 1 mile for every $1 spent on all purchases. Maybe the credit card company even offers you 3,000 miles whenever you spend $1,000 in the first 3 months of opening your account. If you spend $30 at a grocery store with your credit card, you would receive 30 airline miles, and if kept using the card for 3 months, you could reach the bonus of 3,000 miles. These miles can add up over time, eventually leaving you a free flight to your favorite destination. 

There are other perks too, like signing bonuses in the way of miles or points, special cash-back promotions at certain businesses, or special discounts on other services or memberships, like offering new applicants free Amazon Prime services for a year. While most cards come with some sort of incentive system, like cash-back, miles, or both, remember that some cards also have fees. It's common to see credit cards with an annual fee, especially if the card is fancier and comes with really exciting perks. This fee is simply added to the card's statement at the beginning of the year. When you're shopping for credit cards, be sure to keep this in mind! 

Credit Score
Opening a credit card is also an important step in building a strong credit score. If you’re curious about what a credit score is, you can check out our guide here. In general, though, a credit score is an evaluation of whether banks should lend you money when you request money from them. FICO credit scores, for instance, calculate your scores based on:

  • Payment history
  • Credit usage
  • Credit age
  • Credit mix
  • Inquiries for new credit

A good credit score makes applying for a car loan, business loan, or home loan much much easier by showing lenders you aren’t a risk and know how to handle money. Paying your balance on time has a positive impact on your credit score while paying late can hurt it. Keeping your balance low compared to your credit limit also has a positive impact on your credit score, while maxing out your credit card every month, or using all your available credit, can have a negative impact on your score. In general, using about 30% of your limit during a given month is ideal for positively influencing your credit score.

Let’s break that down a bit: Let’s say your credit limit is $2,500 dollars. That means a healthy spending strategy for your credit card would be spending about $750 (30% of $2,500) a month and paying this $750 off before the due date on your statement. Spending more than that 30% can lead to your credit score decreasing. Even if you keep your debt utilization ratio at 30% for several months in a row, you may see a negative impact on your credit score if your debt utilization ratio increases dramatically for a short period of time, even if you pay off your balance in time. There’s a common myth that letting some amount of your balance rollover is good for your credit score, but according to Experian, a top 3 credit bureau, that is simply not true. 

Emergencies 
There is another practical reason to open a credit card: a separate pool of money to utilize when you need it. Credit cards can be great for emergency expenses such as medical emergencies, car repairs, surprise school fees, or moving expenses. In these cases, it’s important to understand your pay-back strategy beforehand. Asking yourself how much interest you're comfortable with paying is a good place to start when deciding how much to pay back before your due date. 

When do I need one? 
Technically, you can sign up for a credit card when you’re 18. You may be an authorized user on your guardian’s credit card. This means that you get a credit card to use that’s tied to the guardian (usually a parent). They pay the bill and are affected by your choices, but also can help you improve your credit score enough to be able to get your own credit card. It’s like a credit card with training wheels. 

Getting a credit card right when you turn 18 may sound scary, especially if you’re just starting out being financially independent, so there’s nothing wrong with deciding you want to develop good money management before opening one when you’re a little older. Like we said above, having strong credit that you’ve built over time is crucial for things like car loans, renter applications, and business loans. So think about the long term: if you feel you’re going to be taking larger financial steps soon, like applying for an apartment in your own name, it may be smart to get a credit card and start working on your credit.

How many should I have? 
There are a lot of people out there who have horror stories about going into massive debt after opening and maxing out too many credit cards. Having multiple credit cards may seem frightening, but it all boils down to how you manage them, as there are benefits to having multiple credit cards eventually. 

Since a credit card is technically a short term loan, think about this like taking out multiple short term loans. This can positively affect your credit score if they’re managed properly, as it can help your credit score by making it easier to keep your debt utilization ratio, or the amount of your available credit that you use, low.

Let’s break that down: if you have one credit card with a $2,500 credit limit and you charge an average of $2,250 a month to your card, your debt utilization ratio is 90%. Where credit scores are concerned, a high debt utilization ratio may negatively impact your credit score. But if you spent that same $2,250 across two cards, your debt utilization ratio would go down. 

debt utilization graphic


There’s no magic number to how many credit cards you should have. Having at least one will eventually become important, but don’t sweat opening multiple unless you have good money management and are aggressive about keeping your debt utilization low. 

Should I pay it off completely every month? 
Experian suggests you do. Paying your card on time is exactly what keeps your credit score from decreasing, or can potentially lead to increases too. Remember that keeping your debt utilization low (even in the single digits) is an aggressive way to keep your credit score high. 

I’m scared of going into debt because I won’t know how to control myself with a credit card, what should I do? 
This is usually a very common, and often irrational fear. If you’re under 25, you have definitely heard horror stories about credit card debt and bankruptcy. It’s important to remember that as long as you use your card wisely, that will likely not happen to you. Remember to only buy on the card what you know you can pay-back within your billing period, and you should be fine. 

If you do need to use the card for something you can’t pay back within 2 weeks to a month, like a medical bill, remember to do your best to not max out your credit card in the process and create a pay-back plan to make sure you’re aware of what your future payments could look like. 

If you’re facing difficulties paying back your credit card balance because of a COVID-19 related issue, or feel you could end up in a situation where that’s the case, contact your credit card company. Many credit card companies have been willing to put people on special and extended payment plans in order to help their customers pay back their balances without extra penalties or interest. 

I’m undocumented – can I open a credit card? 
You may face more roadblocks when trying to apply for a credit card as an undocumented person, but that doesn’t mean it’s impossible. 

Credit card companies ask for your SSN when you’re applying. If you can't get an SSN, don’t have one yet, or aren’t eligible for one, you may be able to apply for an Individual Taxpayer Identification Number (ITIN) from the IRS and use it instead. ITINs are issued to people who need to file federal income tax returns in the U.S. but don't qualify for an SSN. According to Experian: 

“If you don't qualify for either an SSN or ITIN, you can apply for certain credit cards using other identification documents, like a passport. However, you may need to submit your application in a branch or apply over the phone rather than online.”

Experian also notes that having an established banking or credit relationship in your home country may help you in getting a credit card in the United States. Since credit card companies look for good credit scores during the application process, this may be a way to establish that you aren’t a risk and have a good history of money management. 

Here’s a list of credit card companies that accept ITINs, a great place to start if you’re looking to apply for a credit card as an undocumented person:
 
  • American Express
  • Bank of America
  • Capital One
  • Chase
  • Citi
  • OpenSky
  • Wells Fargo

What are the long term benefits of opening a credit card when I’m young? 
You can and probably should keep a credit card for as long as possible. Since the card is linked to your credit score, a continual, healthy relationship with your credit card company means your credit score will remain healthy also. Building a healthy credit score when you’re younger by using your card wisely can lead to benefits down the road of adulthood. A good credit score makes applying for a car loan, business loan, or home loan much much easier by showing lenders you aren’t a risk and know how to handle money. This means lenders will reward you by offering lower interest rates and better lending terms. Using your credit card wisely now means your future self will have an easier time making larger financial decisions. 

What if I want to close a card or if I decide I want to stop using it?
Closing a credit card can negatively impact your credit score, but the extent of the impact really depends on the card’s credit limit and your debt utilization ratio. If you decide to cancel a card with a low credit limit, that won’t negatively impact your credit score as much as canceling one with a high credit limit. Why? Because of how it affects your total line of credit.

Let’s break this down: 
Example 1: 
Let’s say you have 3 credit cards all at a $2,000 credit limit. That means, in total, your line of credit is $6,000. If you spend $1,800 dollars on one credit card, in total, your debt utilization ratio is only 30%, as your total credit limit is $6,000. If you cancel one card, your credit limit is now $4,000. You, still, however, haven’t paid off the $1,800 in credit that you utilized. Because you canceled one card and lowered your total credit limit, your debt utilization ratio jumps to 40%, which is above the ideal debt utilization ratio of 30%. This jump would likely result in your credit score decreasing. 
cancelling a high limit credit card


Example 2:
If you have 3 credit cards, 2 with a $2,000 credit limit and 1 with a $500 credit limit, the situation is a bit different. In this case, your total credit limit is $4,500. If your debt utilization ratio stays the same at 30%, your total spending across your credit limit would be $1,350. If you cancel the card with the $500 dollar limit, that would reduce your credit limit to $4,000. You, still, however, haven’t paid off the $1,350 in credit that you utilized.  Because you canceled one card and lowered your total credit limit, your debt utilization ratio jumps to 33.75%, which is only slightly above the ideal debt utilization ratio of 30%, meaning your credit score would likely not be affected as much.

cancelling a low credit limit card


Due to the way credit cards affect your credit score, experts such as NerdWallet say it's better to stop using a large line of credit instead of canceling it completely. If you really do want to cancel a credit card, we suggest starting with ones that have smaller credit limits to help minimize any damage to your credit score. 

Want to browse credit card options? Check out Nerd Wallet’s comparison tool:

Want to learn more? Check out the great sources we used for this article: 

Juno Team
Written By
Juno Team

Juno came into existence to help students save money on student loans and other financial products through group buying power by negotiating with lenders. The Juno Team has worked with 50,000 students and families to help them save money.