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.
Dave Ramsey is a moron
If you know about finance, you realize a lot of what he says is dumb. However, if you consider his audience, it makes more sense. According to the S&P Global FinLit Survey, only 57% of Americans can answer at least 3 out of 5 basic financial literacy questions (other countries range from 13% to 71%). Dave Ramsey is targeting people who are not financially literate and need very simple rules.
For example: He says to avoid debt, when we know debt can sometimes be good or bad. But for someone who doesn’t grasp the concept of interest rate in the first place, the simple rule of avoiding debt works for them. It is simple.
Kinda like when you learn that the square of a number is always positive. Then you learn about ‘i’ in the next grade. And so forth. Dave targets the people who are still in the 1st grade of financial class, and opinions may differ but arguably he does a pretty good job if his students are learning something useful?
Exactly, which is why I constantly recommend him to others.
If someone says, “I have $20k in credit card debt, why is my minimum payment so high,” they’re a fantastic candidate. If someone says, “I use credit cards and pay it off in full every month,” I don’t recommend Ramsey and would instead point them toward someone like The Money Guy. If someone says, “Am I saving too much? I’m way past the 10/15% these sites recommend, but I don’t know what to buy,” I’ll point to a financial independence resource like JL Collins.
Ramsey is great as a Personal Finance 101 course, but like so many 101 courses, uses a lot of lies to children. And that’s a good thing. I don’t know how many times I’ve made a suggestion on /r/personalfinance and later see it used as dogma later on where it absolutely doesn’t apply. For example, I may say, “traditional IRA is better than Roth IRA” (or vice versa) in one context, but it doesn’t apply in every context, yet I see it parroted later on.
So when we get a wiki/knowledge base, we should absolutely use simplified advice (e.g. Ramsey-esque) by default and point to additional information to determine if your situation is an exception.
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I 100% agree. If we ever get a wiki going, I think the default advice should be to not get a credit card, at least not until getting a full efund, and then to never allow the credit card balance to exceed non-efund cash on hand. That way, you’re treating the credit card as a debit card (always have cash to repay it), not as an emergency fund.
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be a bit more strict for actual emergencies
Agreed. Cash outside of the e-fund should always be sufficient to cover all credit card balance. I call that a “slush” fund, which is money that isn’t part of the e-fund, but also isn’t set aside for longer-term savings goals.
Yup, that’s where I’ve been getting my ideas. Basically I just take Ramsey’s advice and explain why it’s a bad idea, but in neutral language with facts.
Expect to see more posts that demystify Ramsey’s “one size fits all” approach, and see how that advice is not ideal for anyone (but okay for most).
Great post, thank you! Maybe that could be added to the sidebar?
Sure.
I plan to do one of these each week, at least until we get a wiki together. If a mod wants to add them to the sidebar, that’s cool.
Could also post to [email protected]
Some details might be different for Canada/US, but it’s still a nice resource
Feel free to cross post. I’m sure other communities exist for other areas, and we could also benefit from posts there too. Most PF concepts are similar, though CC regulations probably vary.
Excellent ! This is the quality content this community needs.
Note on interest: if you use the “cash advance” feature, and withdraw cash with a credit card, interest will accrue from the first day.
On credit cards not being for everyone: I like to see it as a metaphorical Stanford marshmallow experiment. If you belong to the group who would would eat the first marshmallow right away, credit cards are not for you.
Credit cards are objectively better than debit cards if you can play the game right. They have better protection, cash back, etc… But they do have traps, and you have to be the type of person who can avoid those traps. They are designed to make you want to spend more. Examples: no interest for the first 18 months on some, cash back on most, some are even made of metal and shiny which boosts your ego when you pay at the cash register.
Also this most is mostly relevant for the US, probably Canada and a few other countries. Rules might differ elsewhere.
The correct way to use cash advance is to never use it. Seriously they have a totally different (way higher!) APR that accrues from the first day. Read the conditions of your card and calculate how much you’ll be paying if you take out $100 for example
Much better to get a personal loan if you are in that situation. The interest will suck but way less than cash advance
Agreed, cash advance is generally bad. I have thought about doing it in the past for obtaining foreign currency when travelling abroad and needing to pay cash.
Yes, you get very high interest, but overall, if you compare with alternatives:
- withdraw $1000 using a debit card, you get the standard 3% fee with most banks, end up paying $30 of fees
- withdraw $1000 using a travel credit card that waives foreign currency exchange fees, and pay it back immediately. Maybe the transaction posts within 3 days and you pay 3 days worth of 30% interest. That is still only about $2 or $3 worth of interest depending on their day count convention. Better than the first option.
- exchange cash at a foreign currency kiosk: ouch. Fees are extremely high.
I think the travel credit cards that waive the foreign transaction fee still apply it for cash advance? In the grand scheme of things it is not a huge difference
Oh, I was thinking about the situation where you need cash quickly because you don’t have enough money to cover something. If you can pay it off immediately then that changes the entire conversation.
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.
Does this apply even if you’ve purchased less than the minimum payment? Is there a penalty for buying nothing with a card for several months?
If you purchase less than the minimum payment, you only owe that much.
And the only “penalty” for buying nothing is that they might close your account for inactivity. It’ll still stay on your credit report for 10 years (at least in the US). Usually they don’t close it if you use it at least once per year, but policies at individual banks may vary. I try to use all of my cards at least every few months so they don’t get closed.
Or max it out, declare bankruptcy, and come back in 7 years
That’s certainly one of the strategies out there. :)
Great post! We need posts like this.
One thing I would add about due dates is that since they tend to fall on the same day of the month, they will sometimes fall on weekends or holidays. In the bad old days, it was up to you to make sure the payment got there on the last business day before the holidays. If you were unfortunate enough to have a due date on a Monday holiday, it would have had to get there the Friday beforehand.
When the CFPB was formed, it was able to institute a rule that said that when the due date fell on a day when the bank wasn’t open for processing payments (or a mail holiday), then the payment would still be considered on time if it came in by 5 PM of the next business day.
Still, you do not want to rely on banks getting regulations right, so if you send payments to them, be aware of getting the payment to them at a time they are open, before the due date.
If you set up an auto-pay on the credit card bank’s website, they will generally consider the payment on time, even if it’s scheduled for the weekend. But if you do that, please make sure you look at your statement monthly. If someone makes a fraudulent charge, you only get so long to contest it, and “my bill was on auto pay so I didn’t look at the statement” is not a valid excuse.
I’m glad you like them! I’ve been trying to do a weekly cadence (second so far), but I’ll post a little more often as I see other posts so we can have a good variety for discussion.
“I didn’t look at the statement” is not a valid excuse
Yup. We have several cards, so we use a service that aggregates our transactions across cards. I also have alerts on all that support it set to something a bit higher than my normal transactions.
But at the end of the day, it is on you to detect and report fraud. They’re usually proactive about it, but I have had cases where I caught something before the credit company did (in one case, I had already contacted the merchant when I noticed it was pending to try to prevent it from being shipped).
Good points. :)
I don’t own a car and rent whenever I need one. The car rental insurance with my card has been fine in my experience with the one exception being Salt Lake City. About a year ago I was there and they wouldn’t let me take a car unless I gave them a car insurance policy number to put into their computer. Despite being completely fine in the entire rest of the world, apparently Utah does not accept “I will use the insurance provided by my credit card” as a valid explanation… I was forced to buy the rental company’s crappy insurance that would have likely done more harm than good by buying it.
I travel and rent periodically in SLC, so I’ll have to check up on this. Hopefully it’s just one company or an uninformed clerk. I have auto insurance, but I’ll see if I can do it next time with just my card.
I haven’t heard of Foreign Transaction Fee before, is that different than (and placed on top of) the Foreign Exchange Fee/Spread of anywhere between 1.5% and 5%?
My card has no Foreign Transaction Fees (I think), because I only am charged fees by ATMs, and when I by games off Steam I pay in CAD and the location is in Seattle (but my card is Canadian).
I’m not sure on the nomenclature in Canada, but there are generally three “fees” that could be charged:
- Foreign Transaction Fee - fixed percent charged by credit card issuer (Chase or Wells Fargo), usually 2-3% for purchases in another country; this fee is charged regardless of listed currency
- Currency Conversion Fee - often 1%, charged by the payment processing network (i.e. Visa or Mastercard)
- currency spread - usually a small percentage of the currency quote, since currencies are often traded in bulk instead of at the point of purchase (i.e. the actual CAD <-> USD transaction may happen later that day) - it’s not exactly a “fee,” just a potentially non-advantageous quote for the currency conversion rate; currencies are always fluctuating, so the payment network may profit from the bid-ask spread in the currency markets; credit cards usually give you a better deal than a point-of-sale currency conversion
The first two are likely listed in your card’s plan description, the third is just a thing that happens anytime currencies (or other securities, like stocks) are traded on a market.
At least on my cards, I get charged a separate fee when I make a purchase, so if your statement matches your Steam invoice, you probably don’t have a foreign transaction fee on your card.
when I by games off Steam I pay in CAD and the location is in Seattle
Are you seeing this on your statement, or are you assuming that because Valve is based in Seattle, that the payment is processed there? Valve likely has payment processing handled in each country it operates in, so it’s likely your payment is being processed in Canada, unless you’re buying through a VPN or something. I don’t know that for certain, but I have made purchases by companies based in other countries, but my payments are processed locally, which is usually the case if they have significant business operations here.
https://postimg.cc/gallery/D1QkRpG
Some examples from my banking app and a random statement of mine (the first one was when I bought BG3 lol)…
Steam charges in CAD but the reported location is in Hamburg (Germany) for one of the statements and SEATTLEDE for the other. A 2.5% fee the converted CAD amount applies for transactions in foreign currency, I confirmed with my bank.
Ok, so maybe there’s a currency conversion fee but no foreign transaction fee? You’d need to line up a steam purchase on Steam with bank records, because usually those fees are processed separately (i.e. not included in the price like VAT or sales tax are).
maybe there’s a currency conversion fee but no foreign transaction fee
Yes, it’s like that to my understanding… No separate line items and $0 on the fees charged section of my statement.
Anyways I didn’t know about foreign transaction fees that can be charged even in your home currency, so it was very enlightening, thank you!
Yeah, no worries! I was a bit surprised too because I always assumed home currency meant home processing, but apparently Fanatical charges me in USD, but processes it in the UX, so I get charged the FTF.
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Yup. This post just helps you calculate your minimum payment, ignore the rest. ;)