Credit cards can either be incredibly dangerous or immensely helpful, depending on how you use them. Whether you've been using credit cards for years or you're in the process of getting your first one, it's easy to make mista. This guide will walk you step-by-step through everything you need to know about using a credit card wisely.
Table of Contents
- How to Use and Manage a Credit Card
- How to Use a Credit Card to Build Your Credit
- How to Get Rewards
How to Use and Manage a Credit Card
The number one thing you can do to manage your credit card wisely is to pay your bill on time and in full every single month. That strategy alone will help your finances tremendously. If you don't adhere to this rule carefully, you can quickly end up in a lot of debt and find it difficult to get out.
Pay your bill on time
To avoid interest, late fees, and poor credit scores, you should always pay your credit card bill on time. Charging excessive amount to credit cards isn't the only way that people end up in credit card debt. In fact, a lot of people end up getting into trouble with credit cards simply by missing their payments every month. If you consistently miss payments, you will not only face hundreds of dollars in late fees, but you will also suffer a lower credit score, which could cost you thousands of dollars in interest charges down the road. Paying your bill on time is one of the most important rules to follow when using a credit card. If you can't, it may be time to cancel and cut up your card.
There many simple and effective ways of ensuring you make your credit card payments on time. For instance, most credit card companies let you schedule payments ahead of time or schedule reminders to pay your bill. If you're not comfortable with an automated system, you could also set up a calendar reminder on your smartphone few days before your payment is due so you'll never be late.
Understand the billing cycle
Each month, your credit company will issue a statement with two dates: the statement date (or closing date) and payment date. The statement date is the last day you can make a charge for a single statement. After the statement date, any new transactions will go on next month's statement. The payment date is when the payment for a particular statement is due.
For example, you might have a closing date on the 25th of each month and a payment date on the 15th. In this case, your October statement would run from 25th September to 25th October with a payment due on November 15th. This would mean that you get 21 days of grace period where you won't be charged any interest before you are required to make a payment. Every credit card is different and each one has its own billing cycle, payment date, and grace period. Therefore, you should make sure to carefully review the information for your specific credit card to understand how it works for your situation. This is critical to do especially if you have multiple credit cards to manage.
Pay your bill in full
It is extremely important to pay your credit card bill in full because it allows you to avoid high interest charges and build a high credit score. On average, credit card companies charge an APR (Annual Percentage Rate) of 25%. This high level of interest can result in a very high cost for the cardholder if he is continues to build an unpaid balance on his statement.
Generally, banks calculate interest using your average daily balance. However, the average daily balance calculation is one of the most misunderstood concepts when it comes to credit cards. Many people believe that credit card interest is calculated based only on the leftover balance after they make a payment. However, that's not the case and can lead to hundreds of dollars in extra interest payments.
For example, let's assume that you have a statement balance of S$1,000 and make a payment of S$500 on the due date. While you may think that you will only be charged interest on the remaining S$500, this is not true. In fact, if you have any remaining balance on the card after the grace period, the credit card company will charge you interest based on the average daily balance of your statement period (which is likely going to be much higher than S$500), and you will also forfeit your grace period. Not only that, any transactions you charge to the card afterwards will begin accruing interest immediately. It can often take up to two months of in-full payments to get your grace period back. If you only make the minimum payment, it can lead to years of debt, due to the interest calculation.
Keep your balances low
In addition to making your card payments on time, it's generally wise to keep your balance low, especially relative to your available credit limit. First, a significant portion of your credit score comes from your credit utilisation, which is a ratio of how much you've spent on your card to how much you are allowed to spend on the card. For example, if a card's credit limit is S$1,000 and you've charged S$500 charged to it, its utilisation ratio would be 50%. To maintain a high credit score, you should aim to keep your utilisation below 20%, but closer to 10% is even better. Also, aiming for a utilisation ratio of 20% or less can also help you minimise the chance that you'll spend more than you can pay off at the end of the month.
Monitor your monthly statement
Regularly monitoring your statement can help you check for fraud, stay on a budget and maintain a low balance. Even if you've set up an automatic payment, it's still wise to log in and check your statement every month to make sure there is no irregularity in your statement. Most credit card companies have sophisticated systems that check for fraudulent charges, but they may not catch all fraud charges. At least once a month, you should check your statement and verify there aren't any purchases you don't recognize. Not only that, using credit cards make it somewhat difficult to track exactly how much you are spending on a weekly or monthly basis. Monitoring your statement more closely helps solve this issue and keep your spending in check.
Only charge what you can afford
Lastly, It's highly recommended that you never charge to a credit card more than what you can currently cover in your bank account. People end up with thousands of dollars in credit card debt because they consider credit cards as an extension of their budgets and by spending more than what they can afford without a card. As we've explained above, however, this is a dangerous practice that will prevent you from adhering to our third rule of paying your balance in full.
While it can be tempting to spend ahead based on what you know you'll get paid in the future, it's a bad practice that results in chaos, especially if you lose your job or run into an emergency. By only charging what you can afford in cash currently, you can ensure that you won't pay any interest and always maintain a high credit score.
How to Use a Credit Card to Build Your Credit
Credit cards tend to be one of the most important medium for building credit scores because they are typically one of the first financial products people use. All above our recommendations above are actually also the best way to build your score using credit cards. Below, we explain how credit scores are calculated and exactly how credit cards affect them.
How your credit score is calculated
Your credit score is made up of five key components:
- Payment History: Payment history is based on how reliable you are as a borrower: if you pay on time and in-full, you should be able to build an excellent credit score.
- Credit Utilisation: Credit utilization is the ratio between the amount you borrow (balance) and how much is available to you (credit limit). Lower credit utilisation is generally better for your credit score.
- Length of Credit History: The length of credit history is a simple score based on how long you've used credit: the longer, the better.
- New Credit: New credit measures how often you apply for credit products and what percentage of your credit is related to recently opened accounts. A high amount of new credit is generally bad for your credit score.
- Credit Mix: Credit mix is based on how many different types of credit you use. Generally, more is better.
Using credit cards to build your score
Your payment history and credit utilization make up more than half of your credit score. Therefore, the best way to build your credit score with credit cards would be to maintain a low balance and always make your payments on time. Besides these two things, here are some other precautions that could help you build your credit score:
- Don't cancel your first credit card, unless it has an annual fee, because it will help your average account age.
- Call your credit card company and ask for a credit limit increase but don't increase your spending. This tactic will help your utilisation score by decreasing your ratio.
- Open a new credit card and then set a recurring bill and automatic payment to that card. Setting up this small recurring payment will help both your overall utilization and your payment history.
- Pay off your credit cards a few days before each statement closes. Paying your card bills early will decrease your overall utilisation and boost your credit score.
How to Use a Credit Card to Earn Cash Back & Rewards
Last but not least, using credit cards is a great way to earn rewards and maximise the value of your dollar. In order to get the most amount of rewards possible, you should consider how you spend your money, and then pick a card based on that information.
Analyze your spending to maximize rewards
To get the right credit card, you should first take a look at the past few months of your spending and categorise it as best you can. Do you mostly spend on groceries and other daily necessities like public transportation, or do you spend mostly on shopping and travelling? Once you figure out what categories you're spending the most in, start researching different credit card options that provide bonus rewards on your heavy expenditure categories. After completing this exercise, you may find that you want to use two different cards to maximise rewards. However, while using multiple cards is a good strategy for rewards, you should be careful to not get too obsessed with earning rewards and end up spending more than you usually would.
Cashback vs. miles
The second thing you should look at when maximising rewards is how you prefer to redeem them. Most credit cards in Singapore offer either cashback or miles as rewards. Generally, miles cards are great for those who like to travel, especially if they like to enjoy long-haul trips or business class air tickets. Also, miles cards are great for high-spenders, since these cards don't cap how much rewards one can earn in a given month. However, average consumers could earn more with cashback cards or general percentage cards that provide higher reward rates, though they do limit available monthly rewards.