Intro to Adulting: Credit Cards

We have all been told that you need a credit card to build your credit history. If you don't build your credit history, you won't be able get the loan to buy a car or buy a house; you don't want to rent forever. How about, you need to keep a balance on your credit otherwise it won't show your history.  Or the ever famous, without a credit card, you won't be able to buy things online, make hotel reservations, or breathe air. Again, I don't know what I don't know, if you know, please share. 

While these are somewhat true, there are more to credit cards than that.  (Maybe I lied a bit about the breathe air part). You can definitely buy a house with little to no credit history, it's a lot easier if your credit is spotless though but it can be done. Having credit for cars are a joke really, you'll get better rates if your credit is good but a credit card is definitely not why you'll be offered a car loan. Your debit card can do EVERYTHING your credit card can do except put you in debt and go in your credit history.

Don't worry this post isn't about bashing credit cards or their use thereof.

A Credit card is one of the most dangerous double edged financial inventions ever created, the only financial product more harmful is a payday loan. NEVER take out a payday loan, ask your enemy to borrow you money first if you have to. I'm serious.

If I'm able to share some small insight to how they work, maybe I might help some of my peers before they dig themselves into a debt hole. My goal with this post is to share the little I know of this product and hopefully spark a discussion on its usage. I think credit cards are double edged because the same reasons they are good, make them really bad.

Let's itemize some of these; 

  •  they have a lot of convenience which gives them great appeal but that encourages overspending.
  • they have a predetermined amount of interest free days which encourages a spend now pay later mindset.
  • they have a lot of rewards and points for spending, which again encourages excessive expenditure.
  • they are positioned as a credit building tool but are often the first tool that start a debt tsunami.

I will do this post FAQ style, on that note, let's begin. (By, the way, we'll rename credit card, CC for repetition sake) 

First, is it true you need a CC to build your history?

No. it isn't. You do not NEED a CC to build your history. ANY credit product WILL get reported on your credit report. As a result, any credit product you have will show on your credit report and will count towards your credit score. CCs are usually the most convenient credit product though and have the lowest requirements to get one. They are also VERY VERY profitable for financial institutions, which is why everybody and their finance department is offering you credit cards every day.

Is it bad that I use a CC?

My advice is that you only use a financial product you understand. If you do not understand how it works, DO NOT use it. I could even argue not to use a bank account if you don't know how it works. Better to keep your money under your pillow(this is why we give kids piggy banks by the way). So If you don't know what the fees are for, or why, if  you don't understand how the rewards or cashback program works, what the grace period is, minimum payments, etc., do not use it. Keep it simple. 

Do you (Tolu) use them?

I use them, I mean ONE of them. Costco forced me to get their garbage capital one card (which is still not activated) with their membership but I will dip from that when my membership expires. I only really use my one though. 

How many cards are okay to have?

I currently use only one, I've tested about 4 different cards (3 simultaneously at one point) and I still can't see why you would need more than one.  If you catch yourself playing card roulette, moving balances around or having to remember which one you haven't maxed yet, please stop using your cards instantly. Cut them up if you have to. PLEASE.

How does the interest free grace period work?

This is actually the only good part of credit cards IMO(In My Opinion). So say your CC is defined like so;

Limit - $1000, Grace period 21 days, Interest rate 19.99%, Cash Advance Interest rate 21.99% Minimum payment $10 (plus interest & fees) or the balance if under $10. (Like Math homework problems, life has irrelevant numbers too)

 Today Jan 21st, you spend $100 and that is all you spent this month(Jan 1 - 31). If your bill comes out on Feb 1, you have till Feb 22nd to pay without any interest.

Scenario 1: If you pay $50 Feb 20, and do nothing else, you would pay 19.99% interest on your monthly average when the next bill comes up in March. In essence, paying anything under the full balance at the end of grace period will trigger accrued interest.

Scenario 2: If you pay $100 Feb 20, and do nothing else, you would pay Zero interest. 

Scenario 3: You pay $10 Feb 2, paid $40 Feb 9, paid $20 Feb 20, but paid $30 Feb 23.

Guess what? you WILL have to pay the 19.99% interest on your  average daily balance because the last payment came outside the grace window. They will now ALSO count the previous 21 days of "grace" in the interest calculation.

Last Scenario; You pay $50 Feb 2, spent $200 Feb 3. paid $20 Feb 4. spent $40 Feb 5. paid $70 Feb 10.

In your March bill, you will have zero interest, because you PAID the $100 + an extra $40 but your new bill is now $200. You have another 21 days from the date the March bill comes to pay $200 if you want to avoid interest. 

How does the cash advance interest rate work?

This is where the devil wears plastic.

Do not.

Absolutely do not withdraw cash or do cash advance transactions on your card, I plead with you. So transactions using the CC cheque, transferring money from the CC to your account and some bill payments are considered cash advance transactions.

Let's try the same example as before, 

Limit - $1000, Grace period 21 days, Interest rate 19.99%, Cash Advance Interest rate 21.99% Minimum payment $10 

Jan 10th, you spent $100. You withdraw $150 cash, Jan 21. Your bill is expected to be out Feb 1. 

Luckily, your $100 will still have the 21 days grace between Feb 1 - 22. However, your 21.99% cash interest rate kicks in INSTANTLY on the $150 EVERY DAY from Jan 21. going forward. There is NO grace period for that.  

But that's not all. 

Say Feb 2, you pay $150 to put the 'cash' part back.

LOL. Nope.

What will happen is, $100 will be applied to your "balance", $50 to the cash advance AND they are STILL charging you 21.99% EVERY DAY on the left over $100 going forward.

So if you add another purchase that isn't a cash advance? The cycle repeats until you pay off everything.

How does interest get calculated?

Each institution is different so check with yours to be sure. But the general way;

  • We add the amount you owe each day, and divide that total by the number of days in the statement period. This is your average daily balance.
  • We multiply the average daily balance by the applicable daily interest rate(s) (obtained by taking the annual interest rate(s) and dividing by the number of days in the year). We then multiply this value by the total number of days in the statement period to determine the interest we charge you.  - RBC

Which card is good for XYZ reason/purpose? 

It honestly doesn't matter which card you pick. It is up to you.

If you think you can spend your way into getting a vacation with 'miles', I'm happy for you.

If you want to get points so you can buy whatever from your bank's points shop, I'm happy for you.

If you're like me and only understands cash with a cashback card, I'm extremely happy for you. 

Is there a good way to use this thing then? 

Well yes. The key thing is discipline really. You won't get praised for paying your bills on time, but your credit score will take a huge tumble if you miss payments. Don't miss payments. 

Also, I suggest you use your credit card like a debit card. Use it ONLY when you have the money to pay it off. When you have the money to pay if off, you can put it on the CC. When you have the money, you might as well only use your debit card. #justsaying

My personal usage; I use mine to avoid bank fees. I'm only allowed 12 free transactions/month on my debit card (I know! free account problems). CCs have unlimited transactions. So, I use my CC (also free, no annual fee) for my spending (I monitor this HEAVILY with my budget), and use 1 of my 12 transactions to pay off my card. 

I've had just under $200 paid to me, (cashback, I've paid $0 interest) in my year and a half of using my one card so far. So, I mean, it can be done. I'm not that special in any way.

Any other advice?

If you like to shop; online, in stores, impulse spend OR can't seem to stick to your budget, AVOID a credit card like it is wild fire. It will burn you.

Also, the limit on your credit card is not for you to max out. It is not your money. Do not spend it for stupid reasons. The bank is not giving you free money. They want you to spend and accrue interest. No investment guarantees 20% yearly better than a CC.

20% means DOUBLE their money every 3.6 years!

Your interest is making bankers RICH! 

How/why do you know all this?

I noticed a pattern that CCs were getting offered all over the place and realized there must be enormous profits there. I read my agreement one time and asked tons of questions. I also wanted to understand it properly because I like knowing this type of stuff. I think no one in my age group talks about it so I might as well start it.

Disclaimer: I am not a finance expert. I have no formal training in this subject matter other than maybe reading documents these financial institutions provide in CC agreements.