Uncommon Cents: Don’t get caught in the credit card debt spiral

To have credit means to have the ability to buy goods or services while putting payment off to a future date, based on trust that you will repay the debt. In other words, when you use a credit card, you are borrowing money from a lender and it has to be paid back. Such lenders are banks and other financial institutions, gas stations, department stores and so on. Everyone, but especially students, should be aware of what they are doing when they use these cards, because as convenient as they are, that convenience can turn into a debt trap. Credit cards for students can be an excellent initial stage for developing good credit, but only if used for that purpose.

Credit card debt is unsecured, which means that there are no underlying assets that can be used to back up the amounts borrowed. Credit card debt comes, therefore, with a much higher interest rate than, for example, mortgages. Depending on the card and added benefits, a credit card’s interest rate is generally between 17.5 and 20 per cent, but it can also be less or even up to nearly 30 per cent. These rates do not include special interest rate promotions, which are offered to entice consumers away from their current credit card lender to another. These low interest rates rarely stay low and usually have significant restrictions. For example, if you miss a payment, the rate is often bumped up to the standard (e.g. 19 per cent).

There are some important terms with which you should become familiar.

 Annual fees

Some cards have annual fees, which are often added because the card carries special benefits (travel insurance coverage, cash-back offers etc.). Unless you actually need any of these benefits, make sure your card does not have an annual fee.

Credit limit

Every card has a credit limit beyond which you cannot use the card until you pay down the debt. If you get to the point where you are maxing out your credit card(s), you need to seek some other advice and solutions to manage your debt level.

Minimum payment and grace period

Of course, every card has a minimum payment due and a repayment period. Both are declared on your statement. There is also a grace period of at least 21 days on new purchases during which no interest is charged.

The minimum due is as it sounds: you pay a minimum to keep your card active. However, it is wise to pay off more than your minimum every month. Also note that on your statement there is a federally mandated line that says how long it will take you to pay off your credit card if you only pay the minimum every month. This can be shocking when it might take years to pay it off.

Cash advance 

Another term is “cash advance,” which is exactly what it sounds like: you can get cash advanced to you (within the amount you have left to borrow). This is not recommended: the interest rates on cash advances are usually higher than the standard rate offered by your lender, and you are, in general, also charged extra fees every time you withdraw cash with your credit card.

Annual Percentage Rate and Annual Percentage Yield

The Annual Percentage Rate (APR) is simple interest over the year. But the Annual Percentage Yield (APY) is compound interest: yearly interest on your monthly interest. If you are not properly informed, the APY can be bad for you. You might be paying more money in a year than what was advertised by your lender when you originally bought the use of the card. Ask your bank what the APY might be on your card.

Credit score

As soon as you enter the consumer marketplace (or treadmill), you will start to establish a credit history, which is monitored by a credit bureau. Every purchase, every loan — every financial move you make establishes a score. If your score is too low, you will not be able to get loans, use other financial tools or accumulate assets. Sometimes people get too deep into debt (especially with multiple maxed-out credit cards) and have to apply for debt repair or, worse yet, bankruptcy.

The best way to avoid such a fate is to start now by building financial intelligence. Read the fine print. Understand the terms to which you are agreeing. Research different cards. Pick one that explicitly makes sense for you. Pay it off every month; if you cannot afford to buy something, then don’t. Use credit cards for emergencies only.

 

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