How Credit Cards Work

Credit cards are cards issued by banks or businesses allowing the borrower to purchase goods or services on a line of credit. Unlike debit cards that are tied to your banking account allowing you to electronically transfer money for purchases, credit cards are a great tool for establishing and building credit because the lenders will report to the credit bureaus.


There are many different types of credit cards but we’ll start with the difference between secured and unsecured credit cards. 


· Secured credit card- A secured credit card is a card supported by your money as collateral for a line of credit on the account. The average deposit normally starts around $200 but can be higher. The credit limit usually equals the amount of the deposit. For example, if the lender requires you to fund the account with $300 then normally your credit limit will equal $300. Nearly all lenders offer secured credit cards and these cards are often issued to subprime borrowers or consumers with little credit history. These cards come with higher interest rates and annual fees, but are a great way to build credit and increase your credit score. These lenders will report your payment history to the credit bureaus every month. After making several payments on time, some lenders will automatically qualify you for a unsecured credit card. 


· Unsecured- Unsecured credit cards are not secured by any collateral like secured cards. This means the card isn’t directly tied to any property or anything the lender can seize if you fail to make payment. But if you fail to make payment this will hurt your credit and the lender can sue you, garnish your check, etc. to collect on the unpaid debt. Unsecured credit cards are issued to consumers based on their credit history and financial strength. Normally the higher the credit score and potential earnings, the higher the credit limit. 


Credit card utilization counts for 30% of your fico score so it’s best to keep your credit cards under 30% utilization. Many people have a misconception about paying their cards off every month. It is actually good to leave a small balance to report. This shows the lender that you are using your card and in return they have something to report to the credit bureaus. 


Here’s a few tips to help with credit utilization


· Find out when your card reports (this will help you understand when to use the card)


· Pay card down under 30% (this will increase credit score once it reports)


· Don’t use card until it reports (this will give you leverage if an emergency occurs, you know the card already reported so you have another 30 days to pay it down)


We’ve had many clients misunderstood about why their scores have changed when they pay their credit cards every month. Anytime you use your credit card over 30% this will decrease your score but as soon as you pay the card down you score will increase. So you must know when the card reports to understand when to use it. Some people pay the card down and use it the very next day not knowing it hasn’t reported yet, so whatever balance that was just used is what will actually be reporting. 


There are also credit cards that offer balance transfers, reward points for cash, travel, etc. The better your credit, the more perks you can receive from these credit cards including 0% interest introductory for a period of time.


Another great way to jump start your credit is to become an authorized user on a family member’s credit card. An authorize user means you have someone else’s card in your name but you’re not responsible for the debt because you’re not the primary owner. This can help build or rebuild your credit because the trade line will report on your credit with the major credit bureaus. This can make a huge impact on your score but to get the best results the card must be under 30% utilization and the older the card, the more it will help your score. 

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