5 basic credit card terms you need to understand
Editor’s note: This post was updated with current stats, credit score ranges and interest rates.
If you’re new to credit cards, the jargon and acronyms can be intimidating. The Points Guy can help demystify the terms, help you decide which credit card is best for you and show you the best ways to to earn and redeem points and miles.
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Now’s the time to learn some essential terms and phrases.
Related reading: TPG beginner’s guide: Everything you need to know about points, miles, airlines and credit cards
In This Post Credit Score
You first have to understand the concept of a credit score, the number that indicates your “creditworthiness.” It typically ranges from 300 to 850.
Credit card companies use credit scores to determine if you’re a trustworthy candidate for a new account — they are lending you money, after all. FICO is the company most lenders use to obtain your credit score. Your FICO score is based on the following factors:
Payment history (35%): More than one-third of your credit score is based on how you’ve managed payments on your credit obligations in the past. Derogatory marks like collection accounts, bankruptcy, foreclosures or tax liens hurt you in this category. Amounts owed (30%): You can maintain a good credit score even when you owe a lot of money. But it’s important to keep your debt-to-limit ratio (your “credit utilization”) low on revolving credit cards. In fact, paying down credit card balances is often one of the most effective ways to boost your credit score. Age of credit history (15%): The average age of your accounts, the age of your oldest account and the age of your newest account can have an impact on your FICO score: Older accounts can help your score; newer accounts might do the opposite. Credit mix (10%): Your credit score could benefit when you have a variety of revolving and installment accounts on your credit report. Revolving accounts are generally credit cards and home equity lines of credit, known as HELOCs. Installment loans can be mortgages, auto loans, personal loans, credit builder loans, etc. Credit inquiries (10%): Too many “hard” inquiries on your credit report in in a 12-month period can hurt your FICO score. A hard inquiry occurs when you apply for a credit card.
You can check your three credit reports — Experian, Equifax and TransUnion — online for free once every 12 months via AnnualCreditReport.com. Here are other ways to check your credit score for free. It’s important to monitor your credit report.
What is a good credit score?
Although the FICO score is the credit score most commonly used by lenders, VantageScore is another popular credit score company. The scores are calculated differently as illustrated below:
Both FICO and VantageScore credit scores range from 300 to 850. The higher your score with either scoring model, the less risk you represent to potential lenders. Not only are you more likely to qualify for new credit if you have a high score, but you are also more likely to receive more attractive rates and terms.
Your credit score may be the most important score of your adult life. (Image courtesy of Experian)
Experian, the largest of the three major credit bureaus, shares a breakdown of what’s considered to be a good score with both FICO and VantageScore.
300 — 579
16% of consumers Fair
580 — 669
17% of consumers Good
670 — 739
21% of consumers Very Good
740 — 799
25% of consumers Exceptional
800 — 850
21% of consumers
300 — 499
5% of consumers Poor
500 — 600
21% of consumers Fair
601 — 660
13% of consumers Good
661 — 780
38% of consumers Excellent
781 — 850
23% of consumers What does this mean for you?
All the factors that influence your credit score reflect previous activity on your credit report. When you have no open lines of credit, you are said to have “no credit.” With a no-credit score, credit card companies may be reluctant to issue you a card.
(Photo by Getty Images)
If you’re in this situation, the first step is to establish credit. Consider starting with a secured credit card if you can’t qualify for a traditional, unsecured account. With a secured card, you’ll need to make a security deposit with the card issuer that’s equal to the credit limit on your new account.
The payments you make on the secured card are generally reported to the three major credit bureaus. Be sure to confirm this fact with the card issuer before you apply.
As long as you manage your new secured card properly with on-time payments and low credit utilization, you may be able to qualify for a traditional unsecured credit card in the future. Pay attention to the scoring factors listed above to maintain or improve your credit score over time.
APR stands for annual percentage rate which, by itself, doesn’t explain much about the term. Your APR is the interest rate you are charged on your credit card balance over the course of a year.
Credit card interest is generally calculated daily — 1/365 of the APR is multiplied by your current balance and added to it. This process, called compounding, is repeated daily for as long as you carry a balance. However, any interest charged is typically forgiven if you pay your statement balance in full by the due date every month.
Related reading: Common credit card mistakes and how to avoid them
What is a good APR?
The average APR for credit cards that incur interest was nearly 17% at the time of this writing, according to the Federal Reserve. An APR closer to 10% may be considered good; 20% or higher is bad. However, the APR on attractive rewards cards is generally higher, even for applicants with good credit. That’s why TPG recommends paying off your balance in full each month.
Many cards offer a low intro APR — as low as 0%. Again, your best bet is to not have to worry about APR at all by paying off the balance every month.
What does this mean for you? (Photo courtesy of Shutterstock)
No interest payment, no worries about APR. If you pay your balance each month, it’s essentially a short-term, interest-free loan.
Now the fun part. Many credit cards offer some type of rewards program, such as:
Rewards to a loyalty program Rewards to a transferable points program Cash back
One dollar of credit card spending usually equates to 1 reward point, mile or cent.
What is a good rewards program?
A good rewards program gives you more bang for your buck. Some cards award you 1.5x points or cents in value for every dollar spent. Other cards have bonus categories earning 2x, 3x or even 5x points on certain purchases.
The estimated monetary value of the points varies greatly, depending on the rewards program and its redemption options. Points valuations range from 5 cents per point up to 2.5 cents per point. The higher the points valuation, the more value you stand to get when you redeem your credit card rewards.
What does this mean for you? (Photo by bernie_photo / Getty Images)
The credit card you should use depends entirely on your situation. Find a card with annual travel benefits, free hotel nights or other perks that you can use before you apply. You can start by looking through this list.
Credit cards often charge a fee on your account anniversary to offset the rewards they offer for that account. Annual fees can range from $0 to $450 or more. Typically, the higher the fee, the better the card perks.
What is a good annual fee?
If the value of the benefits or bonus earnings associated with the card outweigh the annual fee, that is a good annual fee. Read more about weighing a card’s fee against its benefits.
What does this mean for you?
Of course, a good annual fee is determined by the benefits and bonuses that you will use. For example, the $95 annual fee for the United Explorer Card comes with a free checked bag. The card’s annual fee is covered by your savings on checked bags once you take a one-way and a round-trip flight. On the other hand, that annual fee does not make sense if you never fly United.
It’s a good idea to do a yearly checkup on your cards. Your account anniversary is a good time to evaluate the credit card and decide if the benefits are worth the fee for another year. Typically, credit card companies give you a grace period of a few weeks to get the annual fee refunded after it has posted if you want to cancel your card. But before you cancel, see if the card issuer is willing to extend a credit card retention offer that might waive or offset your annual fee for the upcoming year.
Credit card vs. charge card vs. debit card
A debit card is different from a credit card in many ways. For starters, you’re not borrowing money when you use a debit card for a purchase. When you use a debit card, the money is deducted from your checking account. There is no credit involved.
Charge cards are much the same as credit cards, at least in practice. Every swipe of a charge card or credit card is a temporary loan from the bank. With charge cards, however, you must pay your balance in full every month. You generally don’t have the option to make a minimum payment or to pay a lesser amount.
Charge cards are also different from credit cards when it comes to credit limits. You can’t spend an unlimited amount on a charge card, but they don’t have a published spending limit like a credit card.
For the merchant, there’s a big difference between transaction fees for debit, credit and charge cards. Credit card fees are significantly higher than debit cards. Charge cards are typically the highest of all. But these fees, at least in the United States, are rarely passed on to the consumer — at least not in a direct way.
What does this mean for you?
When you make a purchase, use the credit card or charge card that gives you the highest return on spending for that specific purchase category. The best choice for dining purchases will usually be different than the optimal pick for spending at office supply stores, for example.
Related reading: The best travel rewards credit cards for each bonus category
Because banks make very little money off a debit card transaction, they typically don’t give rewards for debit card purchases. Debit cards are useful for ATM withdrawals and places where credit cards aren’t accepted. If you have the option, use a rewards-earning credit or charge card. (Just make sure to manage your cards well and pay off your full statement balance each month to avoid interest.)
Related reading: The best cash-back credit cards for each bonus category
It often makes sense to carry a credit card, debit card and a charge card.
Obviously, this is only the beginning of the credit card cosmos. Pair this knowledge with our Beginner’s Guide to points and miles and you’ll be ready to start earning valuable rewards in no time. Once you get rolling, the sky is the limit.
Images courtesy of the author unless otherwise noted.
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