We’re just going to go ahead and assume that you or someone you know may have questions when it comes to credit card lingo.
Sure, you technically know the difference between choosing credit or debit at the register, but have you taken the time to truly understand some of the more complicated terms and phrases associated with credit?
Don’t worry. You’re not alone. Today’s the day you’ll gain clarity and confidence in all things credit card related. Just wait until you’re paying it forward by explaining the ins and outs of credit to your friends. They’ll think you’ve totally got it together. Now if they start asking questions about house cleaning and baking tips, you’re on your own! We are far from neat freaks, and our first batch of cookies always sets the fire alarm off. But we digress. Back to credit…
Here are a few key terms to familiarize yourself with:
Your credit score is a three-digit number between 300 and 850 that banks use to predict risk. From the bank’s perspective, a high credit score indicates you should be able to pay back a loan and make your payments on time. Basically, your score indicates your credibility. See what we did there?
For example, imagine that two friends, Kate and Meg, ask you if you’ll lend them some money until the end of the month. Chances are you won’t let Kate borrow it because the last time this happened, she never paid you back. On the other hand, you’ll probably give it to Meg because you know she’s good for it, and may even treat you to brunch as a thank you! When it comes to credit, be like Meg.
Annual Percentage Rate
Annual Percentage Rate (code name APR) indicates the charge you must pay per year for the amount of money that you borrow. It’s similar to an interest rate in that you are paying back the amount that you borrow, plus a little bit more. Ideally, you want a low APR. And you get that low APR by having a high credit score. See how it’s all connected?
Credit Utilization Ratio
This term might make you want to push your glasses into the bridge of your nose but hang in there. Basically, it’s the credit that you are using. It compares the charges that you actually put on your credit card to the card’s maximum limit. So essentially, it’s what you use divided by what you potentially could use if you wanted to. Banks like to see that you can keep it below about 35%. We prefer you to keep that score even lower.
Each month, you must make a payment towards your credit card balance. The minimum payment is the absolute smallest amount you can pay without getting in trouble. It may sound like a good deal at first because you will be paying less than you actually spent for that month, but this is where real problems can start for folks. Pay the minimum every month, and you’ll eventually get yourself into serious debt. All those charges don’t just disappear. The minimum payment is enough to hold you over, but please don’t make a habit of it. It’s recommended that you pay off your credit card in full. Or, at the very least, never settle for the minimum payment.
Variable Interest Rate vs. Fixed Interest Rate
First things first: “fixed” means it won’t change in finance terms. If you have a credit card with a fixed interest rate, say 15% for example, you will be charged the same rate of interest against your outstanding balance every month. However, if you’ve got a variable rate, you can expect some ups and downs depending on the benchmark interest rate your credit card uses as the base, usually the Prime Rate. Don’t blame yourself when it’s higher – the world of finance is full of drama and sometimes you just gotta roll with it. With that being said, having a low fixed interest rate on your account is ideal.
A.K.A. “Line of Credit,” this term refers to the agreement you make with the bank establishing how much money you are permitted to borrow. It defines all the nitty-gritty terms and conditions ahead of time, so Meg knows the max she’s allowed to borrow each month. Period.
When it comes to credit cards, you need to know what you’re getting into. Understanding these terms will give you the tools you need to start building credit, and more importantly, to stay out of debt. Keep those credit card balances as low as possible, and you’ll be off to a great start. If you still have questions, reach out to us. We’re happy to help. Best of luck!