This story originally appeared on LearnVest.
It’s unlikely that a day goes by where you don’t reach for your credit card, whether it’s to pay for your daily coffee, satisfy a weekly drug store run or fill up the gas tank. And convenience isn’t the only benefit—using a credit card can help you build your credit history, track your spending and even nab some sweet perks if you earn rewards.
But of course there’s the flip side: If you don’t keep close tabs on your charging tendencies, you could end up busting your budget and paying more for your purchases due to fees and interest—possibly contributing to a debt spiral that becomes hard to dig out from.
That’s why it’s so important to understand the credit card basics and be an educated consumer before you even apply for a new card. After all, how will you know how much your swiping is really costing you if you don’t even know what an APR is? (More on that below.)
To help you get started, we’ve rounded up the most common credit card-related terms and translated them into definitions you can actually understand, whether you’re gearing up for your first card or simply need to understand the fine print on the ones you have.
1. Annual Fee
This is a fee a credit card provider might charge you every year simply for owning its card, and it can range anywhere from $15 to upward of a few hundred dollars. Most companies don’t charge a fee, but if they do it’s typically because they offer some sort of substantial perks program (for example, access to airline club lounges or concierge services).
In fact, the only time it might make sense to opt for a card with an annual fee is if its rewards provide a good value for you—for instance, if you’re a frequent traveler and the card you’re interested in has a generous miles program that nabs you several free tickets a year worth more than the annual fee.
One note of caution: Before applying for a new card, always check to make sure that their claim of “no annual fee” is permanent. To attract new customers, some credit card providers may only waive the fee for the first year but then charge you every year thereafter.
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2. APR
APR stands for “annual percentage rate.” Simply put, it’s the amount per year you’ll be charged by a lender to borrow money. With regard to credit cards, the APR largely refers to the interest rate you’re being charged on your balances. APRs typically range anywhere from 0% (although this is usually an introductory rate to entice you to open a card) to more than 20%.
However, the APR only applies if you carry a balance. In other words, if you pay the balance in full by your due date each month, you won’t have to pay interest—a good incentive to make sure you charge only what fits into your budget.
Still, even if you don’t ever plan to run up credit card debt, it’s smart to have a card with a lower APR in case you ever find yourself in a situation in which you can’t pay your balance off in full. In most cases, instead of a set APR, your card provider will indicate a range that your APR could fall into. That’s because most cards have a variable interest rate, meaning the exact APR you’ll have to pay could change depending on a number of factors, including your credit history (the better your credit rating, the more likely you’ll be able to snag a lower APR within that range).
In addition, your APR is influenced by whatever the prime rate is at the time, as well as whatever margin rate your credit card company tacks onto that. (The prime rate is an economic benchmark influenced by the interest rate set by the Federal Reserve; the margin rate reflects the additional percentage points the credit card company charges you for carrying debt.) So in your credit card terms and conditions, you might see your variable APR expressed as the total of two numbers; for example, if the prime rate is 3.5% and the credit card issuer’s margin rate is 10%, your APR is 13.5%.
One other thing to note: Your credit card provider will likely charge different APRs for purchases versus balance transfers versus cash advances, so it’s important to read the fine print before you decide how you use your credit card.
3. Finance Charge
The finance charge is just another name for the amount you may have to pay for carrying debt on your credit card. It’s made up of your APR, fees and other various costs your company may charge you for borrowing, represented as either a flat fee or a percentage of what you borrowed.
But again, if you pay your bills in full every month, you won’t get hit with a finance charge because most cards have a grace period from the time you make a purchase to the day your payment is due during which you won’t incur finance charges (by law, this has to be at least 21 days). That, however, may be the case only for purchases—cash advances may have no grace period at all.
Another reason to read the fine print? Different credit card companies may have different numbers upon which they calculate your finance charge; some may base it on your average daily balance, others may base it on the outstanding balance at the beginning of your billing cycle, and still others may base it on the average daily balance of your current and previous billing cycle.
4. Credit Limit
This is the maximum amount of money your credit card company will allow you to charge to your card. (You might also hear it referred to as a credit line.) For example, if your credit limit is $3,000, you can spend only $3,000 on your card before it’s considered “maxed out”—that is, you won’t be able to borrow any more on that card.
If this is your first credit card, your lender will likely start by assigning you a low credit limit, say $800. But once you’ve proven that you can responsibly pay your bills on time and aren’t regularly maxing out your card, they’ll likely be willing to bump it up, bit by bit.
A higher credit limit can do your credit score some good. That’s because a factor in calculating your score is your credit utilization rate, or the amount you owe on your card divided by your total credit limit. So if you have a $500 balance on a card with a $2,000 limit, your credit utilization rate is 25%. The lower your credit utilization rate, the better it is for your credit score; a higher credit line can help you lower your percentage.
But keep in mind, with higher credit lines come greater responsibility—you have to be careful not to see that bigger limit as an excuse to spend more. One rule of thumb is to try to keep your credit utilization ratio below 30%, but in general, the lower the better.
5. Unsecured Credit Card
An unsecured credit card is called “unsecured” because it’s not backed up by any kind of collateral, like the way a house is used as collateral for a mortgage or a car is used as collateral for an auto loan. Instead, you qualify based on your credit history and other factors, like your salary. This is the most common type of credit card.
6. Secured Credit Card
By contrast, a secured credit card is a special type of credit card that’s tied to a cash deposit you supply up front. For example, if you put down $500 as your required deposit, you’ll likely have a credit limit of $500 (although some secured card issuers will base your credit limit on a percentage above or below your deposit amount).
These types of cards are typically better for people who have a limited credit history, or none at all, and want to build one up, or for those who have poor credit and are trying to inch their scores upward.
As an everyday form of payment it works just like any other card, but because you’re putting down a deposit, it’s typically easier to get approved. (If you don’t pay your bills, the lender will simply keep your deposit.) And since secured credit card issuers report to the credit bureaus just like those of unsecured cards, you have the opportunity to build up your history by proving you’re responsible with your payments (and you're at a smaller risk of digging yourself into debt).
The downside: Some companies tack on a ton of fees and charge high interest rates, since they know those who are looking for secured cards typically don’t have a lot of other options. That’s why it’s important to shop around for a secured card with low fees. Otherwise, your deposit could be eaten up by fees, which in turn could lower the credit limit available to you.
Once it’s clear that you can handle a secured card, your credit card issuer may increase your credit limit or even transfer you to an unsecured credit card.
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7. Balance Transfer
A balance transfer is when you decide to move the debt you owe on one credit card account to a new credit card account. In most cases, people opt for balance transfers so that they can take advantage of a lower APR. That way, they’ll pay less in interest while they work on eliminating that debt.
Many companies tout tempting balance transfer deals in which they’ll offer you a very low or even 0% APR if you decide to shift your debt to one of their cards. On the plus side, that could translate into savings on your interest payments. But this can also come with caveats: For one, you’re applying for a new card, which means a hard inquiry on your credit and a possible hit to your credit score. Second, the deal may not be free—the company will likely charge you a balance transfer fee.
Plus, that appealing low or 0% APR usually sticks around only for a short introductory period, say, six or 12 months. If you can pay off your full debt within that time frame, that's great. But if you don’t, a higher APR will suddenly kick in, and you’ll be back to paying interest.
LearnVest Planning Services is a registered investment adviser and subsidiary of LearnVest, Inc., that provides financial plans for its clients. Information shown is for illustrative purposes only and is not intended as investment, legal or tax planning advice. Please consult a financial adviser, attorney or tax specialist for advice specific to your financial situation. LearnVest Planning Services and any third parties listed, linked to or otherwise appearing in this message are separate and unaffiliated and are not responsible for each other’s products, services or policies. LearnVest, Inc., is wholly owned by NM Planning, LLC, a subsidiary of The Northwestern Mutual Life Insurance Company.
