A credit card is basically a short-term loan. Unlike debit cards, which take your money directly out of your bank account, credit cards allow you to borrow money to pay for goods or services. When you swipe your card, you're not spending your money; you are spending the bank's money. If you pay them right back at the end of the month, you won't incur any interest charges; if you don't, that short-term loan will incur interest every month until you pay it off.
Managing debt effectively is a key part of building your credit, and using credit cards responsibly may be a good early step in that process. However, credit cards can also become (too) easy to use for spending outside of your budget, which can create a pattern of debt that you cannot readily pay back.
Emergency credit card
Some people keep a credit card on them "in case of emergency." Sometimes, unexpected expenses come up that need to be covered immediately, regardless of your cash flow. Credit cards can be a convenient way to cover these types of expenses, but once the emergency has passed, it is important to make a plan for how to pay it off. That might mean cutting back somewhere else for a period of time in order to fit that payment into your budget.
If this is your plan, you should have a pretty clear idea of what constitutes an "emergency" for using your credit card. It might be a no-brainer if you have a flat tire or a family emergency, but what about that new pair of boots or road trip with your friends? If you get used to spending money you don’t have – and won't be able to pay back any time soon – you can quickly end up in a pattern of living outside your means.
Or think of it this way: It's better to "live like a student" now, than have to live like a student later when you have to pay off charges you couldn't actually afford. Future-you won't appreciate using those hard-earned future dollars to pay for all the fun past-you already had.
Planned vs. unplanned debt
Planning around credit cards is essential. There are many studies that show how people don’t perceive credit cards as real money, and will quickly overspend when using a credit card. Credit cards can help in a pinch, build credit, and provide other helpful perks, like frequent flyer miles. The key is to plan your use and set strict guidelines before you walk into a store or go shopping online.
One ideal use of credit cards is to manage your "planned debt," or regular expenses that you can pay off immediately. For example, you might use your credit card only to put gas in your car and purchase groceries – but not for any other purpose – and immediately pull that money out of your bank account to pay off your credit card purchase. If you pay your card off in full each month, you won't have to pay interest on your purchases, while still building credit.
On the other hand, you might be checking out at the store, and the cashier will ask if you would like to save 5% and apply for a store credit card. If approved, your purchase will be applied directly to that new account, even before you leave the store; you'll have a balance on your new account before you even get your physical card in the mail. If you don't pay off that purchase right away, you'll also still have that money in the bank – you borrowed for your purchase rather than spending your own money, so you might be tempted to spend your money on something else while you still have it. By the time you get your first credit card bill, you might not have the money to pay it off. This might even make you reach for your card again next time you're at the store, making another purchase you don't have funds to cover. This results in "unplanned debt" – taking on more than you can afford, and ending up in an expensive cycle.
Tips for credit card success
If you use your credit card responsibly, it can be a great building block for your financial future. Here are some tips to keep on top of your card and your budget:
- Always pay your bill on time. No exceptions! Late payments carry fees, can increase your interest rate, and cause future credit problems.
- Pay your card off every month. Your card's interest charges will capitalize monthly, meaning that your interest charges also begin to accrue interest, making credit card debt much more expensive over time than the original purchase.
- If you can't pay it off completely, always make more than the minimum payment. Maybe you don't have the funds this month to completely pay off your flight home, but if you only make the minimum payment, you could end up paying off that flight for more than a year and spending double the original cost in interest alone. On the other hand, paying it off over a couple months will save you money and still help build your credit. The minimum payment is just the least required amount you have to pay that month, but remember: Banks and credit card companies make their money on the interest they charge you, so they have no incentive to facilitate you paying it off faster.
- Don't ever max out your cards. You should keep your total credit card balance below 30% of your total available – on all cards.
- Don't apply for multiple cards at once. Too many credit applications in too short a period of time can indicate irresponsible borrowing, hurt your credit, and make your interest rates higher. If you actually need more than one card, space them out by at least 6 months or a year.
- Check your account often! Your monthly statement should not be the only time you look at your account – you should check it at least once a week. This can also help you realize if the balance is climbing too high and rein in your spending, rather than being surprised once a month and watching those interest charges add up. Checking your account frequently can also help you spot any fraudulent activity before it goes too far. You might even want to set up transaction alerts, either for all card activity or for any transaction above a certain amount. This might mean receiving/deleting additional text messages or emails, but that's less of a headache in the long run than finding out about fraud too late.
While it may be advantageous to begin building your credit history now, it is also important to consider the impact of a potentially poor payment history on your credit if you open a credit card that you cannot properly manage while being a student. Remember that a choice that works for your friend may not be the best choice for you, so be sure to fully consider your personal situation before choosing to open a credit card.