5 Things to Know Before Applying for a Credit Card

Date posted: July 25, 2016
Credit Card

A credit card is a great tool for making purchases and establishing a credit history, but if used unwisely, it can easily become a gateway to excessive debt problems. Gaining a strong understanding about credit cards is key to using them productively. Here are five key points to consider before applying for a credit card.

How credit cards work

A credit card is issued by a bank or credit card company, and allows you to make purchases now that you pay for later. Interest rates on credit cards average between 13% and 23% annually depending on the type of card. As long as you pay back the money you borrowed on the card at the end of each month, you won’t be charged interest on it. You are not required to pay off the full balance every month, but the credit card company does define a minimum payment each month you are expected to pay. However, for cash advances, where you withdraw cash from your credit card either at your bank, or from an ATM, you are immediately charged a fee that is deducted from your card. If you don’t pay the minimum payment on your credit balance, your card may be suspended.

Unlike an installment loan, where you get a loan then pay it back through monthly payments over a fixed period with a clear start and end date, a credit card can be used over and over again, and does not have an end date when the full balance must be paid off, this is known as revolving debt. People tend to get into more debt problems using credit cards than with installment loans, which require you to completely pay off the loan in a specific period of time.

Credit card repayment determines your credit history

It’s critical to note the effect credit card repayment has on your credit history. Credit history is a record of your debt repayment behaviour. Do you pay on time? Do you pay the balance in full? Are you only making minimum payments? All of this is reported in your credit history. Companies considering giving you credit, or services that involve you receiving something before you pay for it, like phone service or a rental apartment, will want to see your credit history report first.

Credit history determines your credit score

Your credit score is a three-digit number that is calculated based on your credit history. The numbers go from 300 to 900. Lenders use this number to decide whether or not to lend to you - the higher the number, the better. Credit Bureaus, such as TransUnion and Equifax, are companies that collect information about your credit history for credit card companies and banks, and use it to determine your overall credit score.

Building a good credit score is essential to being able to borrow in the future. Some key ways to build a great credit score is to keep your balance at or below 30% of your card limit; pay off your balance every month before or on the payment due date; and always pay more than the minimum payment.

Stick to a manageable credit limit  

Potential lenders may view a high credit limit as potential debt, which can count against you if you are trying to get a mortgage or car loan. Best to keep limits to the amount you actually expect to use.

Whatever your limit, keep your debt-to-limit ratio as low as possible. This is the amount you still owe on your credit card versus the maximum you’re allowed to spend on the card. The lower your debt-to-limit ratio, the better your credit score will be. Say your card allows you to spend a maximum of $1,000, it is best to keep a balance of no more than 30%, or in this example, $300.

Compare different credit cards

As you should before any financial decision, be sure to do your due diligence and compare different cards, and pick a credit card that suits your particular needs and lifestyle.

People without credit history generally start with a secured card. These cards are backed by a cash deposit generally equal to the card’s limit, so even though you made a cash deposit to secure any money you borrow, you still pay interest every time you don’t pay off your balance in full. Alternatively, unsecured credit cards, which are not backed by a cash deposit or any other collateral, have a credit limit based on your income and credit history, and tend to have lower credit limits, especially if it is your first card. Those without a credit history can apply for an unsecured card if they have an authorized co-signer—which is someone would be responsible to make payments every month or pay off the balance if you are unable to do so.

Compare interest rates and fees of multiple credit cards before making your choice. Fees could include: annual fee, balance transfer fees, foreign transaction fees, late fees, and overlimit fees. Also, many cards have different rewards and perks associated with them, such as cash back options, or points towards purchases at particular stores and vendors. Pick a credit card that appeals to your lifestyle, interests, and hobbies.

Those having trouble getting approved for a credit card due to bad credit or prior debt problems should apply for an installment loan from alternative financial lenders such as easyfinancial. With installment loans, you make monthly payments in order to pay down the loan, and since there is a fixed start and an end date in place, you are less likely to get into further debt problems and can slowly start to rebuild your credit.   

Responsible use and repayment of a credit card is an important part of being financially successful. Being fully informed about your options enables you to make the best decision for a credit card that suits your needs and lifestyle.

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