Credit cards are designed to let you make purchases without directly taking cash out of your bank account. That does not mean they should be used to make purchases that you don’t have enough cash to cover. In fact, they shouldn’t.

Why should I get a credit card?

When you use credit cards correctly, you can:

• Raise your credit score, which will help you qualify for things like home and car loans

• Earn benefits like rewards points and cash back on purchases

• Get theft protection and extended warranties on purchases

• Dispute charges when you’re not satisfied with a purchase or you were mischarged

There also are many things you simply have to have a credit card for — online shopping, booking rental cars and making travel reservations, for example.

• See also: Credit reports

How should I use my credit cards?

You should only use credit cards if you have enough cash saved up to pay the balance off in full every month. That way you build credit and get the benefits of your card, but you don’t lose money on interest. You should never use credit cards to pay for things you don’t have enough cash to cover — that’s the single biggest mistake most credit card holders make.

You should never use credit cards to pay for things you don’t have enough cash to cover — that’s the single biggest mistake most credit card holders make.

If you’re not supposed to use credit cards to pay for things that you don’t have cash for, then why is it so easy?

Simple — there’s no one to stop you.

Credit card companies — creditors — make money when you borrow money and don’t pay them back immediately. For every amount of money you borrow, they charge you a percent of that amount called interest. As your credit card balance gets bigger, so does the interest you owe your creditors.

You creditors won’t contact you when they notice your balance increasing and remind you to stop spending so much. They won’t contact you until your balance gets out-of-control and you hit your borrowing limit or fall behind on your monthly payments — and you never want to get to that point.

• See also: Cost of credit tool

How do I get a credit card?

To apply for a credit card, you fill out a short application. The credit card company runs a credit check to review your credit report or credit rating. This gives them a sense of what kind of borrower you will be — if you’ll regularly pay off your cards or if you’ll miss payments — and determines if you qualify.

If the card company qualifies you for a card, you’ll be offered a credit card that has a certain interest rate and a certain credit limit or line of credit. Occasionally, you’ll have to pay other finance charges.

Interest rate

Your interest rate is a the fee, stated as a percentage of your outstanding balance, that your company will charge you if you don’t pay your credit card bill in full at the end of each billing cycle. 

Credit limit or line of credit

Your credit limit is the maximum amount of money that the credit card company will let you borrow.

Finance charge

Finance charges include interest and any other fees you might have to pay for the use of the credit. Some credit cards require you to pay flat fees in addition to interest. Before you take out a card, make sure you know what all the charges are.

As a borrower, you are free to use as much as you want up to the credit limit — this is called open-ended credit. As long as you don’t go over the limit, you can keep borrowing.

What is a credit agreement?

There are two primary types of credit agreements — 30 day agreements and revolving credit agreements.

Thirty-day agreement

In an open 30-day credit agreement, you promise to pay the full balance owed each month. A popular credit card that has a 30-day credit agreement is a traditional American Express. These also are known as charge cards.

Revolving credit agreement

In a revolving credit agreement, you have the option each month of repaying in full or paying payments at least as high as the stated amount. The minimum payment is based on the amount of balance that is due. Most credit cards such as Visa, MasterCard and Discover are revolving credit agreements. Retail store cards and gas credit cards also are revolving agreements.

How do I choose a credit card?

Most credit card issuers have online applications, but first, you should go to a credit card comparison website so you can gauge what type of car would be the bet for your lifestyle. Shop around and compare options to get the best deal.

Here are some website we recommend for comparing credit options:

• Consumer Reports: www.consumerreports.org

• Bankrate.com: www.bankrate.com

• CreditCards.org: www.creditcards.org

When you start comparing options, you’ll come across these terms:

Annual percentage rate

An annual percentage rate (APR) is the cost of your credit stated as a yearly percentage rate. The APR is noted on your bill every month and is either fixed or variable. A fixed percentage rate, despite the name, may be subject to change without notice and could be lowered or raised.

Grace periods

Grace periods allow you to avoid interest charges by paying your current balance in full before the due date. Make sure the credit card you choose allows a grace period.

Annual fees

Annual fees can range from $15 to $25 (sometimes much more) and you must pay whether or not you use the card so shop around to find cards without these fees.

Late fees

Most credit card issuers impose late fees when you make your monthly payment late. These late fees are bad enough, but the fine print may say that since you’ve been late, the issuer can raise your interest rate and revoke any special rates you have in effect, such as balance-transfer rates. Read the card agreement to learn how these fees will affect your interest rate.

Over-the-limit fees

This fee is added to your balance and it will take even longer to pay off your balance.

Credit agreement

A credit agreement is a long legal disclosure document that your card issuer sends you that includes all the terms, conditions and finance charges associated with your credit card. Card issuers update these agreements frequently, and you typically don’t have any choice but to either go along with the new terms or cancel the card.How the card issuer calculates the finances charges is important to know because if the finances charges vary, it will make a big difference in how much money you pay. Credit offers may sound good, but make sure you read the fine print and watch out for offers that are too good to be true.To avoid being taken advantage of, read credit agreements carefully and compare them to offers by known lenders, such as your bank or credit union.

Cash advance

Most credit card companies offer you the option of a cash advance — using your credit card to withdraw cash from an ATM. In general, you never want to take out a cash advance. Cash advances incur fees, and typically interest charges, starting immediately at the time of the withdrawal. This can cost you high interest rates and easily can make your credit balance unmanageable.

How should I manage my credit cards?

Once you have established a credit card, you have the responsibility to manage it. When you open an account, you are entering into a relationship with a bank. You’re signing up to pay back every penny you borrow, plus interest if you don’t pay the money back by the due date.

You also are responsible for reading and understanding the terms of all agreements, including how to address billing errors. If you find a problem with your credit card bill, it’s your responsibility to contact your creditor.

Follow these simple to use your credit cards wisely:

Accept only the amount of credit you need.

Although having credit available when you need it may seem comforting; unused credit can count against you.

Make payments on time.

On your due date, you have until 5 p.m. to make your payment. If your due date is over a holiday or on a weekend, you usually have until the following business day to make your payment. If you are late, finance charges such as late fees and higher interest rates are likely.

Make more than the minimum payment each month.

Minimum payments result in maximum costs. They also mean remaining in debt for a long time. Pay as close to the full balance as you can, and stop using a card the minute you can’t pay the balance off in full.

Don’t increase credit spending when your income increases.

Instead of spending your new extra income, save for your emergency fund or invest it. Avoid the trap of increasing your spending when you increase you income. It’s wiser to reduce your debt.

Keep the number of credit cards you own to a minimum.

Most credit counselors recommend carrying no more than one or two credit cards.

Understand the cost of credit.

Think about how the charges, monthly payment and length of time you will have to make payments will affect your lifestyle. You should also consider how this commitment of future income to paying off debt might affect your budget.

Compare the costs.

Compare the cost of credit from three different sources so you can plan your big purchases carefully. It’s not a good idea to make these types of decisions on the spur of the moment.

Take advantage of rebates.

Most credit card companies provide rebates or rewards programs. A rebate is a partial refund of an amount spent. Some credit cards allow you to accumulate points that can be used for free airline tickets, hotel rooms and more. Just be careful to not end up paying finance charges or accumulating debt that you are unable to repay. The value of points or rebates is always much less than the interest you’ll pay on your unpaid balances.

Get reimbursed for work expenses you put on your personal card.

If you use a credit card for work for travel and food expenses, make sure you submit your expense report immediately and pay off your balance. You don’t want to pay interest on work expenses.

Having high balances and missing payments can harm your credit score and put you in a bad financial situation. Carrying a balance means you are just borrowing against your future paychecks. You end up owing more money than you earn, which can turn into a financial disaster.

Don’t let your balance build. Pay your credit cards off in full each month.

What is the Credit CARD Act of 2009?

Creditors also have rules and responsibilities to consumers to whom they grant credit. Some of the rules can trip consumers up, but the 2009 Credit Card Accountability, Responsibility and Disclosure (CARD) Act — or Credit Card Act of 2009 — changed some things and gave consumer more rights.

The new rules included:

Disclosing rate increases and changes in fees

Rate increases or fee changes must be disclosed to the borrower 45 days in advance. But advance notices do not apply to changes in your credit limit, suspensions on future credit privileges or notices to close your account.

Adding restrictions on interest rate increases due to non-payment

The CARD Act restricts when your interest rate can be increased due to non-payment, usually after 60 days. However, it does not limit that penalty rate, which could be as high as 30%.

Removing charges for inactivity

Credit card companies and issuers can no longer charge for inactivity. However, if you don’t use the card, they may charge an annual fee, lower your limit or close your account.

For more information about your consumer rights, see:

• Federal Trade Commission:www.ftc.gov/bcp/edu/pubs/consumer/credit/cre01.shtm

• Federal Reserve Consumer’s guide to credit cards:
  www.federalreserve.gov/creditcard

How do I pay off my credit card balance?

If you're carrying credit card debt, you are certainly not alone. Follow these steps to help you get out from under this debt. Your goal should be to pay off your debt within 6 months.

• See also: How to pay off credit cards tool

Know your terms.

It’s a good idea to have all of your credit card information in one place so you can contact your creditors should you wallet ever be lost or stolen. This also enables you to see everything in one place: how much you owe, what your interest rates are and more. Grab a piece of paper or start an Excel spreadsheet. Across the top, write or create columns for card name, balance, interest rate, minimum payment and toll-free number. Be sure to keep that in a safe place.

Stop buying things on credit.

To start paying off your balance, you have to stop using your cards to make purchases. You can either call your creditor and tell them you want to close your account, or you can put your credit cards in a safe place where you’re not tempted to use them.

Target your highest interest rate first.

Try to pay off cards with the highest interest rate first. This way will help to save on finance charges in the course of paying all your cards off. Create a chart that includes all your cards, their balances, their rates, their monthly payments and their contact information. Start paying as much as you can — more than the monthly minimum — until they are paid off, starting with your highest interest rates first. Keep working your way down the list of your credit cards until you're done.

Words to know

Unsure about something you read? Many of the financial terms you came across in this article are defined in our financial glossary. A-Z Glossary

Links we like

Here are a couple online features you might find useful:

• White House Fact Sheet on Reforms to Protect American Credit Card Holders: www.whitehouse.gov/the_press_office/Fact-Sheet-Reforms-to-Protect-American-Credit-Card-Holders

• Federal Reserve Consumer’s Guide to Credit Cards: www.federalreserve.gov/creditcard

• BankRate.com: www.bankrate.com