All About Credit Cards

Who this is for 

A recent poll conducted by NEFE shows that four out of five adults in the US wish they were required to complete a personal finance class while they were in school. My daughter, who graduated college a few months ago, is one of them. We discuss personal finance a lot when we meet, with topics ranging from investing in the stock market to taxes to credit cards to why she wasn't born rich. Not that I'm an expert, but I've learned from my many mistakes (see why she wasn't born rich). There's nothing I'd like more than to help provide a foundation of financial literacy for her. I'd love for her to stand on her own feet making thoughtful decisions about managing her money, and not be reliant on anyone else. This is true for my son too by the way, but he's been interested in this space the past couple of years, learning quite rapidly on his own.

So, with that said, I intend to write a few posts covering various topics related to personal finance in the US. The caveat is that I am not a finance professional and none of this should be taken as financial advice. Everything on these pages can be found across hundreds of thousands of blogs, tiktoks, videos, and books - there's zero original content. My target audience is just one person, and I hope this is helpful to her.

Let's start with credit cards. Those pieces of plastic that people whip out at restaurants, or use on their phones when checking out at grocery stores.

What is a credit card anyway?

 A credit is when you receive a product or a service which you plan to pay for later. In this case the product is money, and the way you get it is through a credit card. Think of it as a loan you get from a financial institution. Instead of paying for things directly with money from your bank account, you're borrowing money from the credit card company, which you agree to pay back in time. 

A big benefit of using a credit card over a debit card is that you pay for your purchase much later. Your money continues to remain in your bank accumulating interest until your statement due date. With a debit card, you pay for your purchase instantaneously. I cannot remember the last time I used my debit card for a purchase, honestly.

How credit cards work

When you use a credit card to make a purchase, the credit card company pays the merchant on your behalf. This creates a balance on your credit card statement: the amount you owe, usually the total cost of the items you purchased. At the end of a billing cycle (typically once a month), you'll receive a statement showing all your purchases, the total amount you owe, and a minimum payment due. This statement will have a due date, which is the last day to pay off the amount before accumulating interest. 

Let's go with a made-up example. You used the credit card for a month at a few merchants and got a statement at the end of the month for $100, with a minimum amount of $10 owed by Nov 10. Now the best thing to do is to pay off the entire amount of $100 by Nov 10 so that you can avoid interest charges. If you do not have the $100 by Nov 10 then the next best thing to do is to pay the maximum amount you can afford, thereby reducing your outstanding balance. Interest rates, or Annual Percentage Rates (APR), on credit card debt are incredibly high, ranging from 17% to 29% or more.

Paying the minimum balance is not the worst thing you can do, by the way. The worst thing is not paying anything at all. Not only will you incur higher interest rates on your outstanding amount, you'll have to pay late fees as well. Stick to paying the entire billed amount every cycle and you will be fine.

Most credit cards have a credit limit associated with your account. Banks decide this based on your credit worthiness which takes into account your credit score (more on this in a later post), your payment history, credit history, and credit utilization - the amount of credit you are currently utilizing compared to your total credit available. Another factor is your ability to repay, which is mostly determined by your income. Beginners or students with limited credit history may have a low credit limit (say $1000), but this will increase as you use your card, make regular payments, and add to your income.

Credit card fees

 Some credit cards charge an annual fee for their usage. These cards would have additional perks which to some may justify their high fees. I spend $325 per year to use the American Express Gold card for instance. I do this because I value travel points (see below for details) a lot more than cash back, and the Amex Gold gives me 4 points for every dollar I spend at restaurants and grocery stores. For example, a grocery run at Roche Brothers that costs $50 gets me 200 Amex points, which I can transfer to airlines and get at least a $2 discount on travel tickets. 

Now I realize $2 doesn't seem like much but this spend adds up quickly, giving me fairly significant discounts when I book travel. Amex Gold also gives me $10 a month as Uber cash which I can use for rides or ordering through Uber Eats. They give an additional $10 a month on Grubhub as well, which we use quite often. You can likewise get an $84 annual credit for spending at Dunkin' and another $100 credit for eating out at Resy restaurants. So if you make use of the full amount of all these credits, you'll pick up $424 worth of value, completely covering the annual fee. I confess I don't use Dunkin' but I do use most of the rest, plus the discount on travel, which makes this card worth it for me. That said, I don't think this is a card for beginners, and I would advise picking cards without annual fees and give cash back when you are just starting off. 

Some banks charge a foreign transaction fee if you use the card outside the US, by the way. I personally think this is an outdated system, and there are plenty of institutions that provide cards without annual and foreign transaction fees, and offer cash back points and other perks as well.

Credit card rewards

Many credit cards offer rewards to encourage you to use them. These rewards can be a great way to get extra value from your spending. The typical rewards are:

• Sign-Up Bonuses: These are rewards you get for meeting certain spending requirements within a specific time-frame after opening a new card. For example, "Spend $500 in the first three months and get 20,000 bonus points." I have obtained significant sign-up bonuses by opening new cards, which I've redeemed for either cash or miles with airlines. 
• There is a catch here though: some financial institutions track the number of credit cards you've opened in a two year period, and if it's more than five, they are likely to deny your application. They do this to reduce credit card churning, where you open multiple cards just for the sign-up bonus and don't use them later. Chase has an unwritten rule, widely referred to as 5/24, which does exactly that: they will deny your application if you have opened more than 5 credit cards in the past 24 months.
• Cash Back Points: With cash back cards, you earn a percentage of your spending back as cash. This might be a flat rate (say 1.5% on all purchases) or higher percentages in specific spending categories (eg: 5% on groceries, 2% on gas). You can usually redeem these as a statement credit, direct deposit, or as gift cards. This is extremely useful when you are just out of college and starting your career, as you'd usually want to make every dollar stretch as much as possible. So if your credit card bill was $100 and you've accumulated 500 points as cash back, you would owe them just $95 as each point is valued at 1c. You should be able to do this on your credit card app or on their website fairly easily.
• Travel Points/Miles: These cards earn points or miles that can be redeemed for travel, such as flights, hotel stays, or car rentals. The value of these points can vary depending on the card and how you redeem them. Some cards like my American Express Platinum offer 5x points on travel-related purchases. So if I book a $500 travel on say Delta Airlines using my Amex Platinum, I get 2500 points in my Amex account, which I can redeem for at least 2500 miles which usually converts to a minimum of $25 reduction from my next booking.
• The way to do this is to transfer your Amex points to the airline of your choice. You will need to have a frequent flier account with that airline, and choose that airline as your transfer partner in Amex. Let's say you frequent Delta, and you have 20,000 points in your Amex account. You can transfer this 20,000 to Delta, which almost always shows up right away in your Delta account, which you can redeem for your next flight ticket purchase. 
• Other Perks: Most credit cards have a lot of additional perks, which can come in handy. They include travel related perks such as insurance and roadside assistance, vehicle rental coverage, concierge services, events access, special discounts, cellphone insurance, etc. While you don't want to pick up a credit card just for these perks alone, they definitely don't hurt. What's usually not listed is the benefit of getting extra days to make your payment. That $100 purchase won't hit your bank account right away, unlike using your debit card or Venmo/PayPal. Your money stays in your bank gathering interest until the credit card statement due date.

How to pick the right card

 As with anything, you need to decide what works best for you. At an early stage, I'd argue going for a card without annual fees would work best, particularly one that provides a good cash back rate. If you value travel a lot, then you can look for a card which gives you 2 to 3x travel points for every dollar spent, ideally with zero annual fees or with low fees which you feel confident about recovering through their reward programs. You should also look for sign up bonuses, which offer you say 50,000 miles if you sign up and spend $5000 in the first three months. Remember, you can sign up for more than one card if you like!

Another factor to consider is the ecosystem you'd want to be part of, if you really think long term and want to maximize your points. The American Express cards operate slightly differently compared to the Capital One cards, which are again a bit different from the Chase credit card family. Most of these differences are in their travel and hotel partners, and in how you accumulate points. For instance, accumulating points from the Capital One Venture X card is drop-dead simple: any transaction anywhere gets you 2x points. On the other hand, Amex Platinum gives you 5x only when you use the card on the airlines they support, and nowhere else. You get just 1 point per dollar if you use the Amex for a shoe purchase, for instance. 

I've avoided adding details about backend payment processors like Visa and Mastercard, as there's little to differentiate between the two. They provide payment rails for credit cards like Capital One, Chase, et al. You would rarely need to factor those into your decision around picking the right credit card. Be aware though that while these two heavyweights are usually accepted anywhere in the world, others like Amex and Discover are not. That small restaurant in Kerala might take your Capital One Savor Visa card, but is highly unlikely to accept the American Express Gold.

There are lots of resources out there which explains the pros and cons of each ecosystem so you can make an informed decision.

What to watch out for

The main drawbacks of credit cards are pretty much what you'd imagine: high-interest rates and fees, the temptation to overspend and accumulate debt, and the potential to damage your credit score if not managed carefully. You also run the risk of fraud and identity theft, which is not uncommon these days. 

Regularly check your credit card statements for unknown expenses, no matter how small. Some fraudsters who've gotten access to your card start off with small purchases for a dollar or two, testing out the waters before buying an 85" OLED TV and the latest PlayStation.

You can set up transaction alerts so anything above a certain amount will be flagged right away. The usual caveats around security apply here too: never share your password or PIN, be cautious of emails or texts asking for information, avoid clicking on links from unknown senders, etc. Adding your physical card to your mobile wallet adds an extra layer of security as well. 

What I use

I'm on the Amex ecosystem primarily, though I made the mistake of signing up for the Platinum first, which prevented me from getting a signup bonus for the Gold card. If I had to do it over, I'd start with the Blue Cash Preferred, then get a sign up bonus to upgrade to the Gold, and then get another to upgrade to the Plat. However, I like this ecosystem mainly because of the travel that I do every year, as Amex provides access to a lot of lounges. They also automatically give you Gold status at Marriott, Hertz, and a few other places. In addition to a lot of other rewards and perks, of course.

I like Capital One too, and am an authorized user of my wife's Venture X card. This is a really simple card to earn points with, and their annual fee of $395 pretty much pays for itself with their $300 travel discount and other rewards.

We also use the Chase Amazon credit card that offers 5%+ discounts on all purchases at Amazon, which add up pretty fast. This card does not have an annual fee and has zero foreign transaction fees as well, which makes it a no-brainer to get if you are a heavy user of Amazon.

I have a few other cards too, most of which were obtained for signup bonuses or as part of other investments, which I do not use as regularly as the above set (eg: the Robinhood gold card). I'm still learning though, and there are new cards and updates pretty much every year that keep me on my toes. 

Happy spending!