Credit cards: The basics students should know

Many college students fear owning or using a credit card. What is it about these small pieces of plastic - or metal - that intimidates so many? Worry about debt and poor financial literacy cause many young adults to hesitate when it comes to credit cards. But, knowledge is power, and knowing the basics of how credit cards work can give college students a better understanding of how to use one in smart and efficient ways.

So, how do credit cards work? Credit cards allow users to access an open line of credit. Money is borrowed from an issuer, used for purchases, and paid back to the issuer at the end of the billing cycle. Every month, you receive a credit card statement. This bill includes all transactions from the past billing cycle. The issuer sets a minimum payment, which is the smallest amount that can be paid before late fees are added. 

While only paying the minimum helps avoid late fees, interest rates will increase a balance that’s carried from month to month.

Every card has a pre-approved limit to how much a user can spend, or “available credit.” As money is spent, available credit decreases.

On the other hand, spending increases the credit card balance. The balance is the sum of everything owed on a credit card, including purchases, interest, and fees. 

While it is important to know how using a credit card works, users should also be aware of how to use these cards wisely. There are several factors that play into using a credit card efficiently. 

One aspect of using a credit card wisely is only using a certain percentage of available credit. Experts generally recommend using less than 30%, with 10% or less being ideal. 

It is also important to pay the monthly bill off in full.

“If you pay off the entire balance, then you don't have to worry about paying any interest. But, if all you pay is the minimum monthly payment … you will end up owing a lot of interest, and the interest rate is very high,” said Dr. Kathy Estes, associate professor of finance at Lee.

Credit card usage impacts credit history, which is a record of how debts and loans are managed. 

“It allows you to start building up a credit history. And that can be beneficial so that when you graduate and you're wanting to make some purchases where you might need debt, such as cars or houses, you'll have a credit history established,” Estes said.

Another aspect of credit history that should be considered is credit score. A credit score is a three-digit number impacted by multiple factors in your credit history, including how reliable of a borrower you have been. By using a small percentage of an  available balance and paying off the monthly bill in full, users are more likely to maintain a good credit score.

“A credit score evaluates how strong of a potential borrower you are. The higher your credit score, the more likely you are to be able to get… a loan in the future,” said Estes.

Other things that impact credit score are the different types of credit one may have, how often credit is used, and applying for or closing accounts.

College students are at an important time in their lives in which they are working toward their futures, and learning how to provide for themselves. Having and using a credit card should not be an anxiety-filled process - as long as borrowers know how to utilize these cards well.

“Know your own ability to control spending habits. It can get easy to swipe a credit card, and you just charge it, and you don't have to pay for it yet, but that is debt, and you do owe it, and you will have to pay a high [interest] percentage rate. So, if you don't feel like you have the self-control to not overspend, then you probably shouldn't have a credit card,” said Estes.

It is important to know how credit cards work and how to use them wisely, so that students are able to make the best financial decisions for themselves.