Pick Your Plastic: Choosing the Right Card Isn’t Easy

Blue card

(Photo by MyTudut, via Flickr.com)

If you’ve never carried plastic and are thinking now’s a good time to start, the number of card choices might surprise you. Choosing the right kind of plastic isn’t easy. You’re about to enter a world with such product offerings as credit cards, charge cards, retail cards, petroleum cards, secured cards, debit cards, and prepaid debit cards. They’re all different and they all have pros and cons. Before you decide on which card is right for you, here’s what you should know about each of your options:

Credit Cards

A credit card is an extension of credit by a bank or other financial institution. You’re given a card under the condition that you agree to pay back any monies owed, plus fees and interest if applicable. The amount of money that you can “charge” on a credit card is called a credit limit. The limit defines the maximum amount you can spend on the account—it’s your spending capacity. For example, you might apply for a credit card and get approved for a $10,000 credit limit. Your maximum spending capacity would be $10,000.

Pro: Credit card usage is generally reported to the credit reporting agencies. If managed responsibly, credit cards can be a smart, inexpensive way to build and maintain solid credit and credit scores.

Con: If not managed properly, credit cards can lead to overwhelming credit card debt. Missing payments, paying your bill late and getting into excessive debt can hurt your credit and lead to lower credit scores. However, if you pay your bill on time and stay out of debt, a credit card can actually be a great way to help your credit scores.

Charge Cards

Charge cards are exactly the same as a credit card except for one important difference.  A charge card must be paid in full, each month. Credit cards, on the other hand, allow you to make a small minimum payment and then “revolve” the rest of the balance to the next month.

This is one of the reasons why a charge card may be a better option when choosing your plastic.  With a charge card you can’t get into credit card debt because every 30 days you pay the balance in full, which is one of the reasons why a charge card may be a better option when choosing your plastic. These cards make money primarily on annual fees and they are reported to the credit reporting agencies.

Pros: Because you are not able to “revolve” a balance from month to month, a charge card may be a better option when choosing your plastic. With a charge card you can’t get into credit card debt because you pay your balance in full every 30 days. Charge cards are also reported to the credit reporting agencies and can be a great way to build or maintain solid credit scores if managed responsibly.

Cons: Charge cards primarily make money on annual fees, so you can expect to pay an annual fee if you choose to go with a charge card. Just like credit cards, missing payments, making late payments, or not being able to pay your bill in full at the end of the month, etc., can hurt your credit and lower your credit scores.

Retail Cards and Gas Cards

Many people consider retail and gas cards to be the same thing. Retail cards are issued by a financial institution and are branded with the logo of a retail store or chain. The card can only be used at that chain of stores. Like retail cards, gas cards are also issued by a financial institution and are usually only usable at certain gas stations. The lure of these cards is usually the in store savings or gas rewards.

Pros: The activity on these types of cards is reported to the credit reporting agencies and can be used to build your credit report cards and credit scores—as long as you manage them responsibly, of course.

Cons: Interest rates on these cards are normally much higher than traditional credit card interest rates. If you don’t pay your balance in full each month you could end up paying more than the savings or rewards that attracted you to the card to begin with.

Secured Cards

A secured credit card is issued by a bank, but only after you’ve made a deposit with that bank. The card is then issued with a credit limit equal to your deposit. So, if you deposit $500 into a bank account the bank would issue you a credit card in return with a $500 credit limit.

The deposit acts as security for the bank.  Any purchases you make on the card are essentially already paid for in advance by your deposit. This might give the impression that a secured card isn’t a true credit card product, but that’s not the case. When you use a secured card the payment for your purchases does not come out of your deposit. You will receive a statement at the end of the month with a payment due and a payment due date, just like a regular credit card. The security deposit is only applied to your balance if you default on your payments.

Pros: Secured cards can be a great way to establish and build credit for the first time, as long as the account is reported to the credit reporting agencies. Because you secure the card with a cash deposit, secured cards are fairly easy to qualify for.

Cons: Secured cards require a cash deposit so you need to come up with the cash up front to get the card. Another downside to secured credit cards the low credit limits, which are tied to the total amount of your deposit and generally range from $200 to $1,000, making them easy to “max out” with only a few charges. If you’re using a secured card to build or establish credit, you should limit your spending to keep your revolving utilization percentage – the proportion of your balance in relation to the credit limit – as low as possible to avoid lowering your credit scores. Shoot for below 10%.

Debit Cards

The best way to think of a debit card is to view it as a plastic check. The debit card is issued by a bank or financial institution where you have a checking or savings account. A debit card works like a credit card but purchases are funded by the money in your checking account instead of by a line of credit extended to you by the bank..

Pros: With a debit card you can only spend up to the amount of money in your checking account, which means you can’t get into debt and you won’t pay interest.

Cons: A debit card is not a true extension of credit. As such, your debit card usage is not reported to any of the credit reporting agencies and cannot be used to establish, maintain or rebuild credit reports or credit scores.

Prepaid Cards

Prepaid cards are simply a variation of debit cards. The primary difference is that the money used to cover your purchases on a prepaid debit card is actually loaded on the card itself. This is why prepaid cards are often called “stored value” cards. To get a prepaid card you would actually go and buy it and then load money onto it. You would not have to apply for it because it’s not an extension of credit by a lender that would require them to make a decision about your credit risk.

Pros: You can then use the card like you’d use a credit card but you’d never incur interest and you’d never get into debt.

Cons: The downside to these cards is that they do not help you to build or maintain a credit report or credit score and the list of fees is usually fairly extensive, especially to access your own money.

How to get your first credit card

Now that you know what different types of plastic are out there, you need to educate yourself on how to choose which one is the right one for you. Getting your first credit card is simultaneously a sign and a test of maturity. An exciting feeling of financial power comes with that little piece of plastic on which your name is embossed. This rite of passage empowers consumers over the age of 21 who decide to foray into the universe of credit.

Educate yourself

A credit card is a pre-approved loan and if you carry a balance you will pay for the privilege of using money that belongs to someone else. Learn how credit cards can work to your advantage. For example, if you do all of your spending on a credit card, your budget writes itself; your spending is right there on the statement to track and analyze. A credit card will also allow you to carry less cash, rent a car (not possible with many debit cards) and cover an emergency expense. Like any useful tool, credit cards require some learned skill to operate successfully. A novice can quickly lose control and do massive damage to his financial life.

Forget about it

The interest rate.  Yes, ignore it. For your first credit card, the interest rate will be high no matter what card you choose. More critical at this stage is to establish the habit of paying off your charges every month. If you succeed, the interest rate doesn’t matter (because you won’t have to pay interest on your charges if you pay your payment due in full each month). If you fail, you will pay unbelievably high prices for everything you purchase with the card once you factor in the costs of paying the balances off over time.

For example, if you charge a $1,000 purchase on a card that has an 18% interest rate, and you pay just $25 per month, you’ll spend over five years paying off that purchase, for a total of $1,539. It’s like a 50% off sale – in reverse.

Rewards. The trick with rewards is that they nudge some people into buying things they wouldn’t have bought simply to earn an attractive reward. Your greatest rewards for responsible use of your first card will be a boost to your credit score and a foundation for a debt-free life. Searching for a rewards card that fits your spending habits will be appropriate once you qualify for better credit cards and have demonstrated that you can avoid revolving debt.

Cosigners. If you can’t qualify on your own, don’t apply. Take full responsibility for your own financial account. There’s no urgency to getting approved. If you don’t qualify, find out why, take the necessary steps to correct the situation and reapply in six months. Most first-timers can qualify for a secured credit card, so save enough money to satisfy the collateral requirement and get the card on your own. Be sure to demonstrate a level of responsibility commensurate with owning a credit card and at the same time this will begin your journey to building a credit history.

Pay attention

Pay the bill on time every month. Set up automatic payments or a reliable reminder so that the bill is always paid. Late payments will incur fees and harm your credit score.

Don’t max out your card. Watch your utilization – the amount you charge in relation to your total credit limit. Consumers with the best credit scores keep their balances to about 10% or less of their available credit. Even if your limit is low, if you max out your card, your credit score will take a hit.

Parents: help your child. If you’re the parent, help your child pick a card. Keep a close (daily) eye on their usage. “Throwing them in the deep end and seeing if they can swim” is not an effective teaching strategy when it comes to money management. A young person needs guidance, practice and a good example to develop the healthy financial management skills that lead to great credit scores and long term financial security.

Choose a card

Without a credit history, you will at best be limited to student cards  (if you’re a student) and secured cards. Don’t get caught up in marketing hype. The benefits and features that are most important for your first credit card are not the same as the ones that are important to someone who has been handling credit cards for many years.

For a secured card, the most important features are low fees and making sure the credit card issuer reports to all three of the major credit reporting agencies (Equifax, Experian and TransUnion). If your on-time payments are not reported, the card will do absolutely nothing to help you build the credit you need to qualify for an unsecured card.

If you qualify for an unsecured student card, look for one that has no annual fee and no penalty rate. A penalty rate is an extremely high interest rate that your account is subjected to as a punishment for making a late payment. Some student cards go one step further and waive the late payment fee for the first late payment, allowing the cardholder a little wiggle room when it comes to perfect credit card behavior.

Anyone who travels outside the U.S. frequently, including to Mexico or Canada, should look for a credit card with no foreign transaction fee. This fee can be 2-3% or higher, and it really adds up. It’s an unnecessary expense when so many cards decline to impose it.

Remember, the goal is to use the card minimally and pay it off each month. If you’ve recently been approved for your first credit card, we’d love to find out which one and how your experience has been. Please let us know in the comments.

Credit Card Q&A

We asked our Facebook fans and Twitter followers to share their most pressing personal finance questions. Now, John Ulzheimer, credit expert for Credit Sesame, weighs-in.

Q: I’ve never had a credit card before. How should I get started and what should I know to achieve and maintain a perfect credit score? –David   

David gets an A+ for thinking ahead. Unfortunately, they don’t teach “Credit” in school at any level, which means we have learn as we earn. And, while getting a question wrong on a high school test may not mean much in the long run, getting it wrong in the world of credit can have a major effect on your life—for years. Making poor credit decisions now can mean 7 to 10 years of negative reporting and hundreds of wasted dollars thanks to higher rates and fees on your credit and loans. So, good for David for taking the initiative to figure this stuff out before he takes the plunge. Now, let’s help him out.

Earning a perfect score is practically impossible and completely unnecessary. A perfect score means 850 on the FICO scale, and that takes, among other things, a well-aged credit report card, which you won’t have starting out. In fact, 15 percent of the points in your FICO score come from age related credit report measurements.

If you focus on achieving 750+ (what’s considered an excellent score), you’ll be fine.  You’re not likely to get a better deal from a lender for having 750 instead of 850.  Plus, 750+ is a realistic target for someone who is new to credit.

First things first: Building credit means having credit. Choose a credit card for which you’d like to apply. If you plan on revolving a balance (you can read more about that here), which I hope you won’t do, I’d suggest applying with a credit union. Their rates are likely going to be lower than those offered by the mega-banks.

If you’re not going to carry a balance, the interest rate is immaterial and a rewards card would be a good choice. There are many options when it comes to rewards cards, and it can get complicated. My advice? Choose a cash back card. Cash has no blackout dates, so you can use it when you need it.

Big banks are more likely to give you large credit limits than credit unions. This is helpful when you’re trying to maintain good credit scores at the same time you’re using the card.  One of the most valuable measurements in credit scoring models is the balance-to-credit limit ratio. A high credit limit allows you to use your card without worrying that the ratio is too high.

You want to keep that ratio at 10 percent or below. For example, if you have a credit card with a $20,000 credit limit, you can use up to $2,000 of that limit in any given month without going over 10 percent usage. However, a $2,000 balance on a card with a $5,000 credit limit equals 40 percent usage, which can reflect poorly on your credit.

I’ve said it before, but—to reiterate—missing payments on a credit card can damage your credit scores. So can carrying a high balance. You’ve got a little buffer when it comes to late payments (not that you should take advantage of it). A provision in the CARD Act paired with credit industry policy means that payments must be at least 51 days past the date that the statement was generated in order to show up on your credit reports.

Why 51 days? This can get a little convoluted—even for those of us who aren’t new to the credit world. The CARD Act (or the Credit Card Accountability Responsibility and Disclosure Act of 2009), mandates a 21-day grace period of non-business credit cards. This period begins when the credit card issuer mails or emails the consumer their statement.

On top of that, credit reporting industry guidelines say that the lender can’t report a late payment until it is a full 30 days past the due date. If you’re one or two days late, you may be issued a late fee or some interest, but it won’t show up on your credit report.

Best of luck, David. Credit cards are not evil, as many would have you believe. Using credit cards wisely provides an efficient, safe and practically free means of transacting in commerce. Thanks to the Fair Credit Billing Act, there are excellent fraud protections. Plus, right now, credit card issuers are fighting for good consumers. It’s a good time to be on the “buyers” side of that equation. The next step is to figure out what is an excellent credit score nowadays, and start working toward it.

How to start over with credit cards (after botching it the first time)

During your younger years, you used plastic—a lot. So much so that you decided to go cold turkey in order to get out of the mess you’d gotten yourself in. (As in, you had racked up so much credit card debt that you couldn’t even afford to make the minimum monthly payments.) After several rocky financial years, you’ve dug yourself out of debt and pledged your allegiance to cash.

Then you realized that cash only isn’t the savviest move, especially when you need to prove that you’re a responsible credit user in order to have good credit. To build and establish good credit, you need to show that you’re able to manage your financial obligations responsibly – paying off the balances and paying them on time. And one of the easiest ways to do this is to have a credit card – as long as you manage them the right way the second time around.

So you’ve decided to dip your toes back into the world of plastic, starting over with credit cards. But where should you start?

Step 1: Check your credit report card.

Before you start researching credit cards, you need to know where you stand credit wise. Request a copy of your credit report (available for free at annualcreditreport.com) and make sure that it doesn’t contain any errors. It’s also wise to check your credit score, too, but only after you’ve pulled your credit report and confirmed that there are no errors. Remember, your credit score is only as accurate as the information reported in your credit reports. Once you’ve verified that your credit report is free from errors, you can get your credit score for free with Credit Sesame. This three-digit number will help you figure out what credit offers you’re eligible for.

Step 2: Determine what type of card you want.

Your options? Secured or unsecured. If you’re worried about going into credit card debt again, a secured card could be right for you. (The same holds true if your credit score is still poor.) That’s because a secured card requires a cash deposit, which, in turn, becomes your credit limit. For instance, if you put $1,000 in your account, you can use your card for up to $1,000 worth of purchases. If you decide to go with a secured card, be sure to opt for one that reports your credit behavior to the three major credit bureaus. That way, if you practice good behavior, your credit score is certain to rise — and you could eventually transition to an unsecured card, if you so desire.

Want to go with unsecured plastic? The first thing you should do is think about how you’re going to use the card. If there’s any chance whatsoever that you’ll carry a balance from month-to-month, be sure to opt for a card with a low interest rate. Ideally, however, you’ll never have a revolving balance.

Say you plan to use your card to make several (or a lot of) purchases each month. If that’s the case, signing up for a rewards or cash back card might be a good idea. Many of these cards have an annual fee, so you’ll want to make sure that the rewards you’ll earn exceed the cost of the annual fee or opt for a fee-free one. And if you’re only planning to use the card in case of emergencies or for the occasional purchase? Choose a card with a low-interest rate and no annual fee.

Step 3: Narrow down your options.

There are hundreds of credit cards out there, so you’ll need to reduce that list down to just two or three cards. Then compare your options by reading some reviews online — look for information about customer service, fees, how generous the rewards are, and any extra benefits or incentives that come with the card, like fraud protection or 0% APR for 18 months. From there, choose a card and read all the fine print (found on the issuer’s website) before applying.

Most importantly, when your card arrives and you activate it, be smart with it. Keep your credit utilization at 10 percent or less and always pay your bill on time each and every month. If you do, and you give it time, you’ll see first hand how these simple rules are the keys to the kingdom when it comes to earning great credit and achieving high credit scores.

Credit Sesame roundup – extra resources

Credit cards get a bad rap as the source of misery for many a cardholder. Over the past few years, a lot of consumers have fallen into debt, no thanks to unemployment, bankruptcies, foreclosures and the addiction to plastic. But credit cards should be considered as financial tools for us to use — they aren’t to blame for our money problems. It is our misuse of plastic that leads us to trouble, not the cards themselves. Many people misplace the blame by vilifying cards as the source of their debt, rather than their use of these cards as the true culprit for their monetary problems. In reality though, there’s a right and wrong way to use credit cards, and by using them properly, you can actually even come out ahead! Thus, for this week’s roundup, we give you a few resources that can help you decide whether a credit card could be a good thing for you to have… Or not.

We start the roundup with a writeup on Responsible Credit Card Use. This article from Investor Junkie can help you understand how to use a credit card in a way that won’t let you turn it into a tool for your own financial self-destruction. But be warned, if you’ve seen that you’re way too impulsive for your own good: rethink about whether you’d be better off with a prepaid debit card instead.

Since we’re talking about choosing between debit or credit, let’s hear out Len Penzo as he offers this clever piece on Why Choosing Debit or Credit Is Like Picking Salad Dressing. This would help you understand the differences of both card products and help you choose the right option for you. And no, we’re not going to tell the waiter to give you Italian.

Tipping the scales in favor of credit card rewards is this article by Mrs. Bankrupt called 6 Reasons To Opt Out Of Debit Reward Cards. An informative read on the merits of cash back and rewards credit cards, this is for those of you who have greater self-control in terms of spending and using cash vs credit.

More on the topic of card rewards and cash back, we have Mrs. Accountability of Out Of Debt Again asking this question on rewards points: Buy Something Or Redeem for Cash? While you review this article, you may come to further appreciate reward cards for what they offer.

Since we’re emphasizing self-control in spending and in using credit, here is an excellent interview on overcoming the worst thing that can happen with credit gone wild — the accumulation of credit card debt. Man vs Debt’s Debt-Free For Life: An Interview With David Bach can be a crucial guide to your personal debt reduction. If you’re finding yourself in dire financial straits, you may be able to benefit from this article as it aims to show you that there is always hope in conquering your debt load. It just takes resolve, determination, persistence, and guidance on how to face the battle.

And here is one more push towards helping you obliterate your debt: How I Wiped Out My Debt by No Credit Needed describes an excellent method for paying off credit cards and other forms of debt and loans. Check out the tips in this article and formulate your own plan to tackle your debt and to become financially free soon!

If you read motivational books, you may come across a rather popular riddle that’s often posed to readers. The following question raises a few thoughts and shows an effective way to tackle something as overwhelming and as debilitating as debt:

“How do you eat an elephant?”

The answer?

“One bite at a time.”

The same thing goes with debt and the quest for financial freedom. It’s about taking one small step at a time. It’s about setting small goals that will lead to achieving the ultimate goal of financial independence. Credit cards need not be the villain in this story. The story of financial shadowboxing begins and ends when one realizes that the power punch boils down to self-control, discipline, persistence and patience with oneself. Keep your eye on your credit and use credit cards with care in order to sidestep the troubles that consumer debt can bring.

Disclosure: Credit Sesame is an independent comparison service provider. Reasonable efforts have been made to maintain accurate information throughout our website, mobile apps, and communication methods; however, all information is presented without warranty or guarantee. Please visit the provider’s site for current information and verify all terms and conditions of any offer prior to applying. The editorial content on this page is not provided by any credit card issuer. Any opinions, analysis, reviews, or recommendations expressed here are author’s alone, not those of any credit card issuer, and have not been reviewed, approved or otherwise endorsed by any credit card issuer. The credit card offers that appear on this site are from credit card companies from which we may receive compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). This site does not include all credit card companies or all available credit card offers. All images and trademarks are the property of their respective owners.

* See the online provider’s application for details about terms and conditions. Offers are subject to change and the terms displayed may not be available to all consumers. Please visit the provider’s site for current information and verify all terms and conditions of any offer prior to applying.

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Published January 24, 2012
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2 responses to “Pick Your Plastic: Choosing the Right Card Isn’t Easy”

  1. […] Credit cards with their easy access to available credit may be tempting, but you should avoid using them as a substitute for income. Don’t fall into the trap of using your cards to pay for gas, groceries or monthly bills unless you know you can pay the balance at the end of the month. […]

  2. […] Gas Cards, Credit Cards, Prepaid Cards, Secured Cards: Choosing the Right Card […]

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