5 Basic Credit Card Terms You Need to Understand

Jun 4, 2017

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If you’re new to credit cards, the jargon and acronyms can get a bit intimidating. We’ve offered up some pointers about credit in the past; now’s the time to learn some essential terms and phrases.

1. Credit Score

Before we get into credit cards, you first have to understand the concept of a credit score — a number that indicates your “creditworthiness” and ranges from 300 to 850. Credit card companies use it to determine if you are trustworthy enough for a credit card — they are lending you money, after all. Credit Karma, which offers free credit scores, breaks down the following factors to determine your score:

  1. Credit Card Utilization (high impact): The sum of your credit card balances divided by your total credit card limits.
  2. Payment History (high impact): The percentage of payments you’ve made on time.
  3. Derogatory Marks (high impact): Includes collections, bankruptcy, foreclosures or tax liens.
  4. Age of Credit History (medium impact): The average age of your open accounts.
  5. Total Accounts (low impact): The number of accounts, open and closed, that show up on your credit report.
  6. Credit Inquiries (low impact): The number of “hard” inquiries on your credit report over the last two years. A hard inquiry typically happens when you apply for a new line of credit — like when applying for a credit card.

What Is a “Good” Credit Score?

The FICO score is the most commonly used credit score. VantageScore is another credit score but is calculated differently. Experian, the largest of the bureaus that calculates your credit score, shows the ranges for both:

Your credit score may be the most important "score" of your adult life. Image courtesy of Experian.
Your credit score may be the most important “score” of your adult life. Image courtesy of Experian.

What Does This Mean for You?

All the factors on your credit score refer back to previous activity on your credit report. So before you have any lines of credit open, you are said to have “no credit,” and credit card companies will be reluctant to issue you a card.

If you have no credit, your first step is to establish credit. If you can’t get a traditional credit card, you may have to start with a secured card, which requires you to pay a security deposit that can be applied to your balance if you miss a payment. This deposit is pretty inconvenient and seems counterintuitive for a credit card, but the payments you make on the secured card are reported to credit bureaus. Once good credit is established, you can apply for a traditional card. After that, pay attention to the factors listed above to keep upping your credit score.

2. APR

APR stands for Annual Percentage Rate, which in itself probably doesn’t clear anything up. This is the interest rate you will be charged on your credit card balance over the course of a year, but the charge is actually calculated daily — 1/365 of the APR is multiplied by your current balance and added to it. This process, called “compounding,” is repeated daily for as long as your carry a balance. However, any interest charged is forgiven if you pay your balance in full every month. See more on interest charges.

What Is a “Good” APR?

An average APR is roughly 15% with closer to 10% considered good and 20% or above bad. Many cards offer a low intro APR — as low as 0% — but your best bet is to not have to worry about APR at all.

What Does This Mean for You?

If the above math gave you traumatic flashbacks of high school algebra, the good news is you can disregard APR altogether if you pay your statement balance in full every month. No interest payment, no math — just pay the credit-card company back the money you spent by the payment due date. If you do this, each time you use your card is essentially a short-term, interest-free loan.

You can ignore the math completely if you pay off your full balance every month. Image courtesy of Wikimedia Commons.
You can ignore the math completely if you pay your statement balance every month. Image courtesy of Wikimedia Commons.

3. Rewards Programs

Finally, we get to the fun part. Many credit cards offer some type of rewards program. These are the most common ones:

  • Rewards to a loyalty program
  • Rewards to a transferable points program
  • Cash back

One dollar of credit card spend typically equates to 1 reward point or cent.

What Is a “Good” Rewards Program?

Some cards work in such a way that you get 1.5 points or cents in value for every dollar spent. Other cards have bonus categories earning 2x, 3x or even 5x points on certain purchases. The estimated monetary value of these points varies greatly depending on the program and its redemption options, ranging from 0.5 cents per point up to 2.7 cents per point.

What Does This Mean for You?

The credit card you should use depends entirely on your situation. Find the card with the most benefits you can maximize, whether it’s annual travel credits or a free hotel night after each cardmembership anniversary, and the rewards program that is most valuable to you. You can start by looking through this list.

4. Annual Fee

Credit cards often charge a fee on your account anniversary to offset the rewards they offer for that card. Annual fees can range from free to $550 and above. Typically, the higher the fee, the better the credit card perks.

What Is a “Good” Annual Fee?

A good annual fee is one that’s far outweighed by the value of the benefits or bonus earnings associated with the card. Read more about weighing a card’s fee against its benefits here.

What Does This Mean for You?

Of course, a good annual fee for you only considers the benefits and bonuses that you personally would be utilizing. For example, the $95 annual fee for the United MileagePlus Explorer Card can pay for itself after a few free checked bags, but it makes much less sense if you never fly United.

When the fee is charged each year on your account anniversary, it’s a good time to evaluate the credit card and decide if the benefits are worth the fee for another year. Typically, credit card companies will give you a grace period of a few weeks to get the annual fee refunded after it has posted if you are canceling your account. Before canceling, though, it doesn’t hurt to ask to get the annual fee waived or reduced.

For just a $49 annual fee credit card, you could get a free night at any IHG property, such as the Intercontinental Bali

5. Credit Card vs. Charge Card vs. Debit Card

A debit card is different from a credit card in that you are not borrowing any money. When you use a debit card, the money is deducted from your checking account. There is no “credit” involved.

Charge cards act much the same as credit cards in practice in that every swipe is a temporary loan from the bank. They differ in that you have to pay the balance in full every month. They also don’t have spending limits. American Express is the most common type of charge card.

For the merchant, there is actually a big difference between transaction fees for debit, credit and charge cards. Credit card fees are significantly higher than debit cards, and charge cards are even higher than that. But these fees — at least in the United States — are rarely passed on to the consumer.

What Does This Mean for You?

When making a purchase, use the credit card or charge card that gives you the highest return on spending for that specific purchase category. The best choice for dining purchases will usually be different than the optimal pick for spending at office supply stores, for example. Because banks make very little money off of a debit card transaction, they don’t give rewards for debit card purchases. Debit cards are still useful for ATM withdrawals and places where credit cards aren’t accepted, but if you have the option, use a rewards-earning credit or charge card.

It often makes sense to carry a credit card, debit card and a charge card.
It often makes sense to carry a credit card, debit card and a charge card.

Your Receipt

Obviously, this is only the beginning of the credit card cosmos. Pair this knowledge with our Beginner’s Guide to points and miles and you’ll be ready to start earning. Once you get rolling, the sky is the limit.

Images courtesy of the author unless otherwise noted.

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