Credit cards: What you need to know

1. Getting approved for a credit card

Everyone knows the value of a credit card. With increasing importance of plastic money and online transactions over the Internet, you could easily find it difficult to make many of your purchases without a credit card, and even in cases where you do, you may lose out on the convenience that a credit card offers you. Unfortunately, it’s not always easy to get a credit card. It is an ironic fact of credit card life that you need a good credit history to get a credit card, and you need a credit card to establish that history!

Although things aren’t really as bad as that, they could be difficult in a number of individual cases, particularly if your income is not high enough to support your existing debts plus the new ones that will arise from use of credit cards, you are not able to offer collateral security such as a house that you own, and your history hasn’t been too good.

Is there something that you can do if you’re not found creditworthy enough by credit card issuing companies and banks, and find it difficult to get a credit card issued? There sure is. The name of the game is building confidence and a positive credit history. How can you do this? There are three ways open to anyone who cannot get a credit card issued in the normal course:

1. Secured Credit Cards: These are precisely what the name suggests. You deposit a predetermined amount of money in a bank account and authorize the credit card company to attach this account, and draw the money required for repayment of your credit card balances, in case of default on payment. The interest on secured credit cards is higher than the one on unsecured cards, but then you will at least get a start this way. Other than this one difference, however, your secured card is as good as any other card, and you have all the protections and rights that are available on unsecured cards.
2. Co-signer guaranteed credit cards: In this type of credit cards, another person co-signs along with you while getting the credit card issued. In effect, this person guarantees your payment, and is liable as much as you are, if you fail to repay. In fact, many credit companies won’t bother with you. They will directly recover the payments from the co-signer. This, of course, means that you’ll have to get someone close enough to you to do the needful, and also places a heavy moral responsibility on you to make timely repayments of your credit card balances.
3. Student credit cards: This is available to genuine students. So if you are a student, you can take advantage of this option.

As we saw right in the beginning, the ultimate aim is to build your credit history and inspire confidence in credit card companies so that it becomes easier for you in the future to get a better deal on credit cards. One of the means employed by credit card companies to verify your credit-worthiness, and check on your credit history, is to obtain this information from credit reporting agencies. You have a right to see this information if you have reason to believe that the reporting is unfair. Mistakes can happen due to a number of reasons such as changes in your personal details, disputed charges, fraud and so on.

2. Guide to Balance Transfers

It’s very easy for you to get into a vicious cycle in which you pay high interest rates on credit card balances, because the convenience of shopping cashless with a credit card and the option of revolving credit that most credit companies offer. If you do fall into such a cycle, and find that your monthly payments are very high because of the interest charged on outstanding balances, which can be pretty high, you can consider balance transfer to another credit card. How does this work?

The good thing about credit cards is that there’s a lot of competition among the credit card companies with each wanting a higher share of the available pie. That’s good for you, because these companies frequently offer incentives to lure the customers of another credit card company into their own fold. All you have to do is to transfer your balance to the new credit card company, which generally offers a period of zero interest. During this period, which is typically six months to fifteen months, you do not pay any interest on the amount outstanding from transfers. The advantage of this arrangement is quite obvious. Suppose you have a balance of $1,000 and your credit card company is charging you 18% interest, you are paying an interest of $15 every month. In the absence of this interest you will be able to make the repayment much faster using the same installment amount.

There are a few things that you need to keep in mind before opting for a transfer, though. The first is that transfers cost you something - typically around 3% of the amount with a minimum amount that is levied, irrespective of how much you transfer. If your balance is too small, transferring it may be costlier than bearing the interest under the existing company.

Secondly, if you have a long standing relationship with your existing credit card company, you should try and negotiate with them instead of transferring the balance. If you explain that you have a better deal from another company, most credit card companies wouldn’t mind working out a special rate for you.

The actual process of transferring is not very complicated, but has a number of variations in the way it is done. You can fill up the necessary forms that will be given to you by the new credit card company (to which you want to transfer the balance), and they will do the rest. Alternately you can contact the new credit card company and make the necessary arrangements for the transfer. You can also use balance transfer or convenience checks to pay off your old balances. These are checks that look and act like normal checks, but have a date of expiration before which they should be used.

After you have transferred the balances to a new credit card, you should be aware of a few things. The first is that when you make purchases on your new card, they attract interest, even though the balances themselves may be free of interest. When you make payments, the company will adjust these first against the balance payments, so that you could end up accumulating interest on fresh purchases. The second important thing to remember is that credit card companies charge additional fees for late payments, and on card use over and above your eligible credit limit. Being unaware of these, or not taking care of them, could well land you right back into the credit cycle from which you just escaped.

3. Use your cash advance wisely Credit cards are extremely useful tools in today’s world, and give you not only the convenience of purchasing goods and services without using cash, and through a variety of means such as using the Internet, but also give the convenience of being able to pay later, thus advancing in effect, a fixed amount of money to you for a limited period of time. That’s not all. They also advance hard cash to you that you can withdraw from any ATM by just pushing in your card and typing your password or PIN. Like all good things in life, this also comes at a cost. Remember, there’s no free lunch. So you need to use this facility with the greatest discretion and care.

Credit cards generally charge a higher rate of interest on cash advances. Moreover, cash advances also attract a one-time transaction fee that is generally around three percent of the amount withdrawn. What that means is that if you draw a sum of $500, you may be paying $15 as transaction fees upfront. Credit card companies also charge a higher rate of interest that works to around 20% on your cash withdrawal balances, which will be applicable from day one. If you plan to use this as a source of short-term credit, you should think twice because this is one of the costliest sources for that purpose. Suppose you draw $600 and plan to repay it in six months at $100 a month. The interest that you will be incurring for these six months on $600, $500, $400, $300, $200, and $100 will work out to a total of $35. As you can see that’s fairly heavy on a borrowing of $500 for six months. The problem is that you may not realize that it is costing you so much.

That doesn’t mean that you should never use the cash withdrawal facility of credit cards. After all, it is a convenience that is available to you in your time of need. Just be careful before using it, and make sure that you really need to borrow the money and cannot use your own resources before opting for cash advances from your credit card. More importantly, never make it a means of regularly bridging your budget gaps. If you find that you are withdrawing money too often, to meet your regular needs, you should certainly watch out. In that case, better personal financial planning is obviously called for. Remember that there’s no escape from making the payments ultimately. You are only postponing the payments by borrowing. Instead of making that a regular habit, you should look at ways by which you put aside the money required for your everyday needs. As they say, if you fail to plan, you are planning to fail.

One rule of thumb that you can set for yourself is to use credit only for purchase of assets and goods that will stay with you for a longer time. This way, you will be enjoying the benefits of owning the item over a longer period, while you pay for it.

4. Get out of Credit Card Debt

Credit card debts can become daunting. One estimate puts the average amount owed by Americans using credit cards at $8,000. That‘s a lot of money particularly when you consider the interest rates applicable. More significantly, that’s just an average, and averages can be notorious in misleading you. Try crossing a river whose average depth is marginally les than your height and you’re sure to drown midway! So when we say that the average amount of credit on credit cards is $8,000, we also mean that maybe some people have a debt of $16,000, while there are others who have no debt at all. What the above estimate tells us is that in individual cases the amount of credit card debt can be very high. If you’re one of them, you should be looking for ways to reduce it. While the problem might look tough, the solution actually lies in using your common sense, a bit of control over your affairs and discipline over your actions, and some knowledge of the options available to you. That’s all it takes to get out of credit card debt.

As you can see, the approach to follow is a two-pronged one. First of all you need to reign in your credit card habits, and control your usage. The basic fact to remember in doing so is that credit is meant to be used for occasional and large purchases, and for unforeseen events such as sickness. If you use credit for meeting your regular day-to-day expenses, you will be accumulating a debt over a period of time unnecessarily and avoidably. Suppose you have a monthly expenditure of $3,000 on regular items. You have to make a payment of $3,000 every month in any case, unless you can somehow reduce this expenditure. Taking a loan by using your credit card for this expenditure only postpones the problem, and in fact makes it worse by accumulating that amount over a period of time. So the first rule is to use your credit card only for extraordinary purchases and expenditures, and not for routine expenses.

Suppose you have already accumulated a debt on your credit, that advice will bring little solace to you. It’s all very well to say that you should avoid using your credit card for regular expense, but what if you’ve already done it. In that case, you’ll have to take some drastic action and also do some planning to stem the tide. First of all, stop using your credit card any further, and for any purpose whatsoever. The first step in tackling a debt problem is to avoid accumulating more of it. Secondly, make a plan by which you can make the compete payment of the outstanding over a specific period of time. If you are able to work out something like that, but find that the interest is killing you, you could consider transferring your balance to another card, so that you get a breathing time.

What happens if you are simply unable to make the payment, no matter what you do? In that case the only option could be to file a bankruptcy petition. However, before you even begin to think of it, remember that the consequences can be very damaging and extend into the long-term. So use it as a very last resort, and only if you have absolutely no means of repaying the debt.

5. Everything About Creditors

Creditors want their money back. It’s as simple as that. This is particularly true of bankers and other professional financiers, who make a living out of lending. Otherwise they would go out of business in no time and also ruin themselves. So a creditor naturally looks first at the probability of getting his or her money back, and charges a rate of interest commensurate with the perceived risk. If the risk is too high, the lender doesn’t lend at all. How does a lender assess the probability of getting his or her money back? The answer lies in three simple Cs: Capacity, Character and Collateral. The principle behind these three Cs is very simple.

Capacity: Let’s say your friend needed $50,000 for an emergency operation. If your friend had no assets, and his income was $4,000 a month with matching expenses, no matter what his intentions are, your friend wouldn’t be able to repay your loan.

Character: Now let’s say your friend had enough income, but is a heavy drinker and gambler, who habitually borrows from friends, and rarely repays the loans. Although your friend may have the capacity to repay the loan that he is asking from you, going by his past record, you would rate the chances of his repaying your loan as quite poor.

Collateral: If the above imaginary friend of yours were to have a poor income, and also a poor history of repaying his loans, and approaches you for some money, you are pretty sure to reject his request. If the same friend were to give you a costly jewelry worth many times the loan that you would be advancing, and tells you to keep it with you as security against the loan, the picture changes drastically, as in that case, you need not worry about getting back your money. That’s what collateral is all about.

Creditors assess these three factors while evaluating the credit worthiness of a person and take a decision to advance a loan based on them. It stands to reason that if you lack in one of these areas, but would still like to get a loan, you would try to strengthen your position in another area. For example, if your credit history is poor, you could offer collateral to get credit. In fact you could use one factor to get a loan and over a period of time strengthen another factor of yours. You could get credit on guarantee or collateral, and over a period of time build up a positive credit history.

You can also independently work on these factors. For example, if your credit rating is poor, you could look into the details of credit rating agencies to understand why your credit rating is poor. If your repaying capacity is poor, you could look into your pattern of expenses and existing loans.

There’s also a law to protect your interests. It’s known as the Equal Credit Opportunity Act. What it says is that you cannot be denied a loan merely on grounds of your age, gender, religion, race, color and so on. In short, while creditors have every right to apply their standard criteria before deciding to grant you a loan, they must do so in a manner that is fair and free of discrimination.

6. Lowering Your Interest Rate

I’m yet to come across a person who doesn’t want a good bargain. Sure I haven’t been to the Himalayas, and met one of those Tibetan monks who are supposed to be free of any desire for money. But that’s about it. I think everyone else loves a good bargain. In the big bad world out there, money is really a commodity that is available to you at a price. The only difference is that this is a commodity that you don’t purchase for keeps, but one that you have to return after use. So when one is talking about money, one is interested in the interest rate (is that why it is called interest?), and the repayment terms. Just as you are interested in getting the best possible prices on the goods that you buy, you should be interested in getting the best possible interest and repayment terms in the case of a loan. The question is: how do you get a lower interest rate on your credit card?

The fundamental approach to reducing your interest rates is essentially the same as one that you would follow while making a purchase of goods - ask for a discount or a lower price. What are the chances that this approach would succeed with your credit card company? Much depends on how valuable your business is to the company. If you have been regular in your repayments without overshooting your credit limits, you would be assessed as a good customer, and chances are that you would be heard, particularly if your demand were backed by what the market offers. You could add some spice to your demand by throwing in some offers of lower interest that you might have received from other companies. As a matter of fact, if you have really received such offers, and chances are that you would have, if you are an average American, then you could sift through those offers, and consider a change-over to one of them if your present credit company refuses or is unable to match that offer.

Don’t take all this too literally, though. If you have a long-standing relationship with your present company, it might not be worthwhile to terminate such a relationship unless the gains are really great. Moreover, sometimes appearances can be deceptive. You may see a lower interest rate on paper, and switch over to the new credit card company, only to find that the offer of a lower interest is limited to a specific short period of time. If that is the case, it obviously doesn’t make sense to consider a change over. So the key to the decision is to consider what you are getting in the short-term and the long-term, and take a decision only if you are satisfied that there are long-term advantages.

If you are a user of credit cards at your department stores, you are probably paying a high rate of interest that makes your credit card look cheap. Department stores credit cards charge interest at around 20%. In some cases the interest rate could be as high as 30%. Needles to say, you should stop these cards, if you are serious about reducing your interest rates.

7. Identity Theft

In good old days theft was limited to physical goods. Someone could steal your money, jewelry, valuables, and may be even you car; but that was it. The Information age and plastic money have brought in a new concept – identity theft. Scary as it is, most people are blissfully unaware of it, or at least don’t feel threatened by it, unless they are directly affected. Just recall the last time someone told you that she was charged for items that she never bought. Such incidents are becoming increasingly common, so that chances of your having heard of such an incident are quite high now. Even if you haven’t heard of a first hand experience you sure would have read about it in the papers. How does it happen? How can you be charged for transactions that you never initiated? The answer lies in identity theft.

The fact of the matter is that there are lots of people out there, who steal vital information about you – information that empowers them to manipulate your bank accounts and credit card transactions. Using the information that is theirs now, they can transfer funds and purchase things, for which you are charged. If you didn’t know it, it’s time you did – you should take all precautions to protect your identity from intruders and thieves. The key to doing this is to restrict the information that you make available in terms of content as well as recipients. Do not part with information to unknown or unauthorized persons. Where you need to furnish the information, give only the minimum required. Take care to ensure that you do not provide too much information on any one document. Placing your social security number and driving license number on your checks is an example of how you could be providing too much information unnecessarily at one place making it easy for identity thieves.

Identity theft in its worst form can take the shape of assuming the total financial identity of another person. While it is bad enough if you have to suffer a fake check passed in your name or have your credit cad stolen and misused, a total identity take-over can be much worse. In such a case, the thief typically takes the social security number or other identification, and applies for a credit card in the name of the original owner. After using the card for some time, the thief disappears without leaving a trace. The problem is that if it is your identity that he has stolen, you could be left battling for years to correct the damage done to your credit history and standing.

More than the damage done in dollar terms, it is the damage to your credit image, and the trouble that you have to go through to correct it, that you should be worried about. You can take some precautions to prevent identity theft. Although there is an impression that identity theft is essentially a geek’s job and requires specialized skills, it’s not true in most cases that are reported. Most crooks use fairly simple methods that you can easily guard against with some care. The following should help you do that.

• Don’t part with your financial and personal information to strangers.
• Don’t divulge your social security number on any document unless legally required to do so
• Destroy by shredding or burning old documents containing financial information
• Take care to create passwords that cannot be easily guessed. Using your maiden name, or other information that can be easily associated with you, can be a potential source for hacking.
• If you get too much mail from credit agencies and financial companies, remove your name from their mailing lists.
• Check your credit standing periodically.
• Last but not least, notify any fraud immediately on becoming aware of it, and ensure that you file a police complaint also. Inform credit rating agencies.

8. A One-Two Punch

Credit card companies offer to transfer the balances from your existing credit card to their own with the promise of zero interest for a specified period of time, which is typically six months, but can go up to twelve or even fifteen months. This obviously is a great deal for you, particularly if you have a large balance of unpaid amount on your existing card on which you are forced to pay around 20% interest. Where’s the catch? Why would credit card companies make such an offer to you that make them lose interest for the initial period on the debt that they have taken over? The answer is very simple actually, and lies in the fact that it gives the credit card company an opportunity to increase its future business from you. More importantly, the company can reduce or even eliminate the real impact of the zero balance facility if you start using the new card immediately, as the company will charge you normal interest on your current purchases using their credit card. It is the latter that you should be aware of, and take care.

Let’s see how this approach, which although fair by any standards, is likely to hurt you, if you are not aware of the details. Let’s say that you transferred $1,200 from your existing credit card at 0% interest for six months. Let’s also say that you bought $300 worth of goods every month on your new card during this period of six months. The credit card company applies your payments first to the outstanding amount that has been taken over at 0%, leaving out the current purchases that are charged at around 20%. This means that if you had planned to pay $200 every month towards the transferred amount plus the actual value of purchases every month, you would be paying $500 each month. Unfortunately, the entire amount of $500 that you pay will be applied against the balance that you have transferred, leaving the $300 purchase subject to normal interest rates. Thus in effect, you enjoy interest free facility only on $200 of your transferred amount. Depending on how you manage your purchases during the interest free period, you may effectively get the entire transferred amount free of interest as promised, or may end up paying interest on the entire amount without knowing it.

From this it appears that the best option available to you is to avoid making any purchases on your card. I’m sure you’ll agree that that’s easier said than done. So if you can’t avoid using a credit card for purchases what do you do? You could use a second card exclusively for purchases, and keep the card to which you have transferred the balance free of any transactions till you have paid off the entire transferred amount. You could make a plan to ensure that you make this payment within the free interest period. In case you are unable to come up with a plan that could enable you to pay off the entire amount within the stipulated period, you can always consider transferring the balance that remains unpaid in the new card at the end of the grace period to a new interest free card! Whichever approach you use, the key to gaining from the deal lies in understanding the issue well, and acting smarter than the credit card company.

9. Rewarding Behavior

The attractions offered by credit card companies for use of their card towards meeting business expenses are many. If properly used, these incentives can help you manage your business better by planning and monitoring your expenses more systematically, and cutting down on costs, which is not merely a major attraction for a small business owner, but is often a matter of necessity. What are the incentives offered by credit card companies, and how can you make judicious use of them to cut down your costs?

Known variously as vendor savings programs, reward or discount vendor programs, these help you to save money on purchases that you make for your business anyway, and cover a wide range that includes free travel and cash back.

The schemes offered by most credit card companies are made in such a manner that they can directly contribute to the financial well being of your company. One direct and straightforward method is to offer cash back facility that is typically around 5% of the purchases that you make with the credit card. If you consider this facility a little closely, you will realize that it can add up to a big amount at the end of the year, since 5% actually translates into $500 on a $10,000 purchase or $1,000 on a $20,000 purchase over the course of the year.

MasterCard provides a good example of the rich facilities that you can get from credit or debit card usage. MasterCard provides cash back to the regular business user, and also usage incentives to the infrequent user. In addition, there are a number of creative services that help you with direct mailing and include costs of handling and forwarding. You can also get targeted discounts at major business merchandise sellers such as IBM, Office Depot, and Pennywise.com. MasterCard also has a program under which business card holders can get a reward point for every $2 spent. Another great attraction is that you can combine the points earned on your business card with those on your personal card.

The reward points earned can be redeemed against a number of useful and necessary expenditures such as air travel, hotel bills, and electronics. You can also get discounts at many places such as Home Depot, Office max and Best Buy.

For the creative thinker, these reward points and incentives could present a world of possibilities that go beyond simple cost savings. One such use could be to motivate employees by allowing them to enjoy the reward points, thus rewarding them for their hard work, and keeping them motivated. Such an approach would be Win-Win-Win approach with you, your employee and the credit card company benefiting in a handsome manner.

While cost savings, and possible employee motivation, are certainly tangible benefits, with more that can be added through imaginative application of the rewards, the main advantage to you as a small businessperson lies in the financial system and discipline that it enforces, helping you to automatically track your expenses and leaving you free for more creative and productive work.

10. What can I do to improve my credit score

If you’re wondering why you should bother about your credit score if you keep out of trouble and make payments before they reach flash point, here’s some solid reason why you should. Put simply, a good credit score makes it easier to obtain credit in future, can increase the amount of credit that would be available, and most importantly, will reduce the cost of such credit. In fact, this is true not only of individuals but also of businesses and even large corporate houses.

Let’s say you had some money to invest and had two options before you, both giving you equal returns, but one of them being considerably riskier than the other. Where would you park your money? The answer to that question should also tell you why you should care about your credit score.

What can you do to improve your credit score? A lot, in fact. For starters, you could keep checking your credit score periodically. If you don’t, you might be in for some nasty surprises, given the extent of malpractices and misuse, not to speak of misinformation. You can easily get your credit score checked from any of the major credit rating agencies by paying a small fee.

Apart from checking your credit score regularly, you can also take a number of steps that will keep your score high, and prevent it from falling. Some of these are given below.

• Make your payments on time as far as possible. Delays in payment are often as much the result of laziness or indifference, as of genuine difficulties. Even if you have a genuine reason that prevents you from making timely payments easily, try and find out some way by which you can overcome the problem.
• If you are not able to make the payment on time in spite of your best efforts and good intentions, make sure that you minimize the impact of the late payment. You can do this by negotiating a payment schedule with your creditor that allows you more favorable terms of repayment and provides you with some breathing time.
• If for reasons such as prolonged illness or unemployment, you are unable to do such a restructuring, notify the credit rating agencies of the circumstances under which you have been forced to delay payments. This will be added to your credit history, and substantially reduce the impact of your delayed or failed payment in the eyes of anyone who reviews your credit history in future.
• Don’t have too many open credit card accounts. Although you may not be using all of them, and hence may not have a debit figure commensurate with the open credit cards, they will be seen as potential debits that you could incur in future, and will therefore reduce your credit score. So the moral of the story is that if you aren’t using a credit card, don’t keep it.
• What if all the above fail, and you end up with a poor credit history? In such a case, your focus should obviously be on improving your score in the future. Although you may not be able to do this overnight, you can certainly do it over a period of time, with a bit of patience and discipline. One way to do this is to open new accounts that you pay on time. This will help in establishing a better credit history.

For additional information on credit cards or related topics please visit our library of credit card articles.