How to use a credit card: Part 3.

In the last post I went through the basics of credit. It was in no way comprehensive but I tried to touch on the things someone most needs to know in order to manage their credit score and understand how it's created and maintained. In this post, I'll get to the point of all this: how to use a credit card.

Let's start with three popular reasons someone might obtain a credit card.

1. To ease the cost of day-to-day living. This is, in my opinion, the most common reason people apply for cards. And with our mediocre dedication to the financial education of youth, it's also how we think of credit cards when we're just starting out on our own: supplementing the cash we have (or, in the case of many students, don't have). If it's true that fully half of Americans could not come up with $400 in an emergency, then it's easy to see the void credit fills when there's so much uncertainty piled on top of bills, childcare expenses, student loans, groceries, transportation, and the tiny bit you might set aside to do something nice, just to to feel human.

2. To build good credit. This is popular too, and has become more so over the last decade as sites like CreditKarma allow people to see an approximation of their credit scores and track how their decisions affect them for good or ill. Read reviews of secured cards on any website and you'll hear the same story over and over: "I needed to rebuild my credit after bankruptcy/a divorce/an expensive hospital stay/defaulting on my student loans," etc. etc. etc. etc. Because credit card companies report to the credit bureaus each month, it is an incredible opportunity to increase your credit score as time goes on. When factors like number of open accounts, credit utilization, payment history, and average age of accounts are so important, even using just one card responsibly can really have an amazing impact.

3. To reap rewards. You may have seen articles every now and then about how one crazy guy has 98 credit cards and uses them to fly all over the world and stay in luxury hotels, all for free. I hate those articles. But they illustrate the fact that you can make rewards credit cards work for you. You don't have to be nuts, or have half a dozen of them. If you enjoy analyzing the impact of your spending on miles or points accrual, and especially if you enjoy planning vacations and compiling information to get the best rates, then rewards cards are a no-brainer. But it's not just about travel - cash back cards can be pretty great too, especially if you have better-than-average credit.

Credit cards are also useful when renting cars and booking hotel rooms, as the use of a debit card usually requires several extra steps like employment and housing verification. Rental car companies in particular will put a hold on the card for a certain amount (in the low hundreds of dollars) while you rent, and it's hard to have a good vacation if your debit card is missing a chunk of change.

How to use a credit card: Part 2.

In my previous post, I tried to spell out the basics of credit cards by hitting the most salient points I wished I had known before I ever signed up for one. Credit can be a minefield if you are unprepared, but there is good news: you can play the game well, and maybe even win sometimes. Read on to find out how.

What is a credit score?

Your credit score is a single three-digit number which tells lenders how creditworthy you are; or, simply, how likely you are to repay the debt. Scores range from 300 to 850. Within this range are categories, as follows:

• below 600 - bad credit
• 600-649 - poor credit
• 650-699 - fair credit
• 700-749 - good credit
• 750+ - excellent credit

Personally I think the words used to describe each category ("poor," "fair," "good") are finely tuned to keep the average person from feeling too good about their score. Just a personal nitpick I have. Also, be aware that there are slightly different credit scales depending on the credit bureau.

Creditors will extend credit with certain terms based on your score. The better the score, obviously the better the terms.

Get to know your credit score.

Your credit score takes into account six main factors:

1. Credit Utilization Ratio: this is the percentage of credit you are using of the entire amount available to you. It only applies to revolving credit, not installment loans (like school, personal, or mortgage loans), so essentially, it applies to your credit cards.

2. Payment History: quite simply, have you paid all your debts on time? Even one missed payment can really drag your score down, because this is in some ways the most important factor to a lender - will they pay me back or not?

3. Derogatory Marks: this is the serious stuff like collections, foreclosures, defaults, and bankruptcies.

How to use a credit card: Part 1.

When I was in college all dorm rooms had landlines, which meant credit card companies would call us constantly, trying to sign us up for an account. Pretty shady, and addressed during our little economic meltdown later that decade. Unfortunately the lure of being able to spend more than c. fifty dollars a month was too great, and I gave in spring of freshman year to Citibank. Later that year, I also sold my soul to Discover.

As you can imagine, I was an idiot with both cards, which is a whole other story I'm too ashamed to tell, and it was a mighty struggle to become debt-free, after which I swore off debt for several years. Along the way, I learned a lot about the good, bad and ugly of credit and credit scoring. Today I have one credit card with a nice credit limit and I spend all my time obsessively not using it.

You can be like me. In fact, I want you to be. So now, for Part 1 of this series, I will launch into everything I wish I had known when Citi and Discover were unethically cold-calling me back in the day.

It's not free money. Period.

Credit cards are not the answer to your prayers. They are not for funding things you cannot afford. They are not for spontaneous splurges. They are not for paying other debts. They are not for when you feel like you want to "be bad." Credit cards are not fun. Credit cards do not make life easier. Credit cards do not give you freedom.

Now that that's been established.

The concept of credit is simple: borrow a sum of money to be paid back in installments over a period of time. It can be helpful in a number of situations, a few of which I'll enumerate at the end. But at no time in human history has credit ever been the same as a gift. If you open a credit card for the purposes of repaying it in installments, you will end up paying more than you borrowed. End of story.

Everyone knows that you have to pay back what you spend with a credit card, but a lot of people don't know how it works. When I got my first credit card I didn't know how to interpret the statement I received, so it was a few months before I understood that I was being charged money on top of what I had actually spent. This wasn't a problem for a long while - I was responsible enough, and they gently increased my credit limit as time went on so I was never in a bind...until I did start approaching that credit limit.

I would call (yes, call) the customer service number to hear my balance. Good enough, I'd think. I'd call back a few days later, having paid my bill but not used the card - yet suddenly I had fifteen or twenty available dollars less than what I thought I should.