This was originally published on Monday, August 14, 2017, in the Pacific Daily News. Click here to subscribe to the PDN.
Credit cards can be a great tool to build credit, but they can also be financially dangerous. A credit card is nothing but a tool. Depending on the skills, knowledge, and self-control of the user, it can be helpful or harmful. Understanding your credit card and its terms is vital to using it properly.
Your credit and debit cards may look very similar, but they work very differently. Credit cards are a revolving line of credit, credit that is automatically renewed as debts are paid off. Your debit card is electronically linked to your checking account. Here are some other differences:
- Spending limit. Your credit card limit is set based on your credit score — the better your score, the higher your credit limit is. Your debit card is limited to the funds you have in your checking account. Both can be assessed an over-the-limit fee if you go over available funds.
- Interest rates. If you pay your credit card’s full balance off each month, you won’t have to pay interest. If you make a monthly payment, you will be charged an interest fee based on your balance. A debit card has no interest changed. If you keep funds in your account, you may be paid some interest.
- Payments. You can pay your credit card balance based on how much money you have. You can pay the minimum required monthly payment up to the full balance of your credit card. With a debit card, your account is debited almost immediately when you make a purchase.
- Fees. Most credit cards charge an annual fee, late payment fees and over-the-limit fees. If you try to make a purchase using a debit card and don’t have enough money to cover the charge in your account, you may incur an insufficient fund fee.
- Receiving cash. You can use your credit card to get money from an ATM, called a cash advance. Most credit cards charge a different, higher interest rate for cash advances. If you use your an ATM of your debit card’s financial institution, or a point-of-sales machine at a store, you may not have to pay a fee. For both credit and debit cards, there are usually fees associated with using a different financial institution’s ATM.
- Effect on your credit. Your credit card affects your credit history. To build a positive credit history, you should use your card regularly, pay off your monthly balance in full, make your payments on time, and not close your account unless you absolutely have to. Your debit card may affect your credit history if you constantly go over your account balance and are charged overdraft fees.
Secured vs. unsecured
There are two types of credit cards, secured and unsecured. A secured credit card limit is determined by the amount of cash deposited before being able to make a purchase. The cash deposited acts as collateral, something provided to a lender as a promise of payment/reimbursement.
Secured credit cards are a great opportunity to establish a good credit history. Unlike a prepaid credit card, your cash deposit doesn’t run out. You continue to make payments and will incur interest if you don’t pay off your balance in full. If you cancel your secured credit card or transition into an unsecured credit card, you will receive your deposit back if your balance is paid off.
Unsecured credit cards don’t require collateral, so issuers take more of a risk. Because of this risk, issuers rely heavily on your income level and credit history.
Most first-time credit card users don’t have a long enough credit history for issuers to approve a large amount of credit. Many times, a co-signer is needed.
Michael Camacho is president and chief executive officer of Personal Finance Center. He has more than 20 years of experience in retail banking and at financial institutions in Guam and Hawaii. If there is a topic you’d like Michael to cover, please email him at firstname.lastname@example.org and read past columns at the Money Matters blog at www.moneymattersguam.wordpress.com.