Definitive Guide: How To Maximize the Value of Your Credit Cards and Personal Loans
For many Americans, knowing how best to manage our finances isn't something that comes naturally. This guide will demonstrate the best ways to get the most from your credit usage — namely in the form of credit cards and personal loans.
Why did I write this guide?
The average American adult did not learn financial literacy – the basics on managing their money – in school. That has caused many of us to make poor credit decisions that led to crushing debt.
Check out these recent statistics:
The average graduate owes $40,000.
Nearly half of new graduates owe $20,000 – double than just 10 years ago.
The percentage of graduates who owe $50,000 has tripled in the last decade.
With that amount of debt already owing, people need the best information on credit products, as well as all the tips and tricks to use them fully to your financial advantage.
Who is this guide is for?
This guide is for anyone considering applying for a credit card or a personal loan. Determining how you borrow not only affects the health of your credit score, but the financial security of your future. Making good borrowing decisions now is vital. This guide will help you understand the ins and outs of credit cards and personal loans, and how each can be used to your advantage.
Educating yourself on how to manage debt takes the fear out it and empowers you to have control over your finances. In addition, the advice and tips I provide can help make your credit card or personal loan work for you instead of against you.
How much of this guide should you read?
Read the guide from the beginning. I cover some important concepts in Chapter 1 that will be referred to and built upon throughout the guide. Without understanding these concepts – FICO scores, APR, etc. – you will not be able to fully optimize the benefits of credit cards and personal loans. Understanding the rules will equip you with massive leverage for using these financial products to your advantage.
Table of Contents
From how credit cards are processed, to understanding credit strength, to the advantages of owning credit cards; this chapter will provide a comprehensive overview of everything you need to know about the little, plastic cards in your wallet.
Now that you understand how credit cards work, we will move on to cover the ins and outs of personal loans. Where do you get them? How do you get approved? What are good reasons to apply for a personal loan? I will cover all that and more.
Some final thoughts about credit cards and personal loans, as well as asking yourself the hard questions.
What are Credit Cards & Why Do You Need One Anyway?
Credit card: (noun) a small plastic card issued by a bank, business, etc., allowing the holder to purchase goods or services on credit.
What is a Credit Card?
A credit card is a plastic, wallet-sized card issued by a financial institution that allows the user to pay for purchases by borrowing from the bank, usually at the point of sale. The bank then provides a grace time of about a month to pay the bank back before it begins to charge interest on the total you borrowed.
Anatomy of the Credit Card
Hard to believe such a small piece of plastic can wreak such financial havoc if it is misused!
Different Kinds of Credit Cards
We have moved beyond the classic, big-name credit cards that are issued by your bank – VISA, Mastercard, American Express, Discover – to financial products that are customized to the user's needs. For example, if you have no credit history or bad credit history, you can begin to build or repair your credit with a secured credit card. Or, if you are a regular customer at a particular store, you can apply for a co-branded credit card that offers you bonuses and savings. Let's take a look at how the different kinds of credit cards work.
Personal Credit Cards
These are one of the major credit card associations that are issued by banks. Some, like VISA, are almost universally accepted by merchants.
Secured Credit Cards
Secured credit cards are a great way to build or rebuild your credit. Essentially, the bank takes no risks in issuing the card because you have to provide an initial deposit that usually covers the credit limit on the card. This does not, however, mean that it's ok for you to miss a payment. The bank will be informing the credit bureaus of your payment history and that will be reflected in your credit score.
Co-Branded Credit Cards
Stores, airlines, hotels, restaurants and more, all seem to have credit card offers that provide rewards based on customer loyalty. These cards are issued by a financial institution, but provide incentives from the merchant who also appears on the card.
Credit Card Rewards
Most credit cards (especially co-branded credit cards) offer rewards including cash back, purchase savings, travel, etc. using a point system. The more you spend, the more points you receive that you can later redeem for rewards.
FAST FACT: Cardholders love rewards
In 2016, 60% of American consumers ranked rewards as the most attractive feature on their preferred credit cards.
How Do Credit Cards Work?
The concept is really quite simple. The bank issues you a card that extends you a certain amount of money you can spend using the card. The issuer provides a grace period for you to pay back the amount you have spent every month before they begin to charge interest. If you do not pay the total amount owed off every month, then you begin to accrue more debt over time.
Here is a really quick explainer video called "How Do Credit Cards Work" created by the Michigan State University Federal Credit Union that will give you the basic concepts of how credit cards work.
How are Credit Cards Processed?
When the retailer swipes your card, there is a whole series of electronic communications and transactions over the credit card company's network that take place before the your receipt is thrown into you bag and you walk away.
There are several players involved in every credit card transaction. Here is a brief description of each and then I will show you how they interact with each other.
#1 Credit Card Companies
Credit card companies provide the payment network that links the cardholder, merchant, acquirer and issuer. Sometimes, as with American Express, they issue the credit cards directly and do not include an issuing bank in their network.
Collectively, these credit card companies provide cards to 629 million people:
- Visa: 323 million
- MasterCard: 191 million
- American Express: 58 million
- Discover: 57 million
FAST FACT: Why do less merchants accept American Express?
More merchants accept Visa and Mastercard payments than American Express because Am/Ex fees are substantially more – 65% of Am/Ex's revenue comes from merchant fees.
#2 Credit Card Issuing Banks
The issuing banks pay fees to become members of the credit card companies' networks. They then can offer credit cards through their bank.
2017's Biggest Credit Card Issuers
- Chase: 93M Cardholders
- Citibank: 48M Cardholders
- Capital One: 45M Cardholders
- Bank of America: 32M Cardholders
- Wells Fargo: 24M Cardholders
- US Bank: 18.5M Cardholders
- Credit One: 6M Cardholders
- Barclaycard US: 418K Cardholders
#3 Credit Cardholder
This would be where we (customers) come in. We provide an application to the issuing bank for a credit card. The bank, using the information you filled out on the application and data from the credit bureaus, makes a decision about providing you with a credit card and what terms (credit limit, APR, etc.) they will offer you.
#4 Merchants or Payment Gateways
The merchant is essentially the store where you use your credit card to make a purchase. Payment Gateways refer to the online portal you use when you fill your little shopping cart icon and check-out.
FAST FACT: More Americans are using credit cards
For the first time, the payment processing company TSYS's survey revealed more Americans preferred using credits cards in 2016. When making purchases, 40% reached for their credit cards instead cash or debit – a 5% increase from the previous year.
These are the banks that service the merchant accounts. They provide the Point of Sale (POS) system and charge the merchant fees to use and process credit card sales.
Processing a Credit Card Sale
All of the following electronic communications and transactions are made using the credit card company's network.
- The issuing bank approves a credit card to a customer (cardholder).
- The customer makes a purchase with a merchant.
- The merchant swipes the customer's card through the POS system.
- The POS system contacts the acquirer to inform them of the sale.
- The acquirer contacts the issuer to confirm the customer has enough free credit to make the purchase.
- The issuer authorizes the amount.
- The acquirer sends an authorization code back to the merchant.
- The merchant completes the sale.
Settling a Credit Card Sale
Just because you are long gone from the store doesn't mean the process is over. Now everyone must reimbursed for your sale.
- At the end of the day, the merchant batches all their credit card sales and send them to the acquirer.
- The acquirer send the total batch amount for credit card sales from your issuing bank to them.
- The issuing bank takes out their interchange fees, sends a small portion of that to the credit card company, and sends the balance to the acquirer.
- The acquirer takes its discount fee and sends the balance to the merchant.
- The issuer includes the total amount you spent on that sale as part of your monthly credit card bill.
- You pay your bill.
It looks something like this:
FAST FACT: Banks make most of their profit on merchants
Credit card issuing banks do not make most of their profits from credit card customers. The largest chunk of their profit comes from fees charged to merchants called interchange fees. In 2016, merchants were charged almost $33.8 billion.
Swipe Fees: The biggest hidden credit card cost
According to the Merchants Payments Coalition, hidden swipe fees that are passed on to merchants and customers unfairly inflate the profit to banks and credit card companies. Most merchants who are not mega-merchants (think Walmart) need to pass on some of the interchange costs to customers in order to turn a profit. So, these unseen costs are inflated in secret and passed on to you every time you use your credit card for a transaction.
Where do the interchange fees go?
- 13% towards credit card processing
- 97% directly to issuers, acquirers and credit card associations
What do banks and credit card companies do with the 97% of interchange fees they receive?
Most of it goes to mailing unsolicited credit card offers.
Fat swipe fees have created a perverse incentive for the big banks to abandon responsible underwriting practices in favor of a fee-driven business model in which virtually anyone can get a credit card. Inflated fees charged on lending means that banks care more about maximizing fee income than making sure borrowers can afford to repay their loans.
So banks are in the business of making money. Tell us something we don't know. However, because these fees are hidden, merchants and customers cannot make decisions on what payments to accept and what payments to use. In fact, the Coalition asserts that the real cost of transactions has fallen to almost zero with the advent of computer and internet technologies. Credit card companies have forbidden merchants from offering discounts to customers who purchase using cash or debit.
How do the fees affect cardholders?
According to the Merchants Payment Coalition, customers can save 5-10 cents at the gas pumps by using debit or cash instead of credit cards, but that isn't advertised anywhere.
Credit Card Billing Cycle
Credit cards are called revolving credit because you borrow and pay over-and-over again. The billing cycle is more or less between 25-31 days.
When you make a purchase, the issuer provides a grace period, usually 21 days, for you to pay for it without incurring interest. You will receive a monthly statement by mail or by email that details all your purchases and your balance owing. If you do not pay the entire balance within the grace period, your next monthly statement will include your past balance along with applicable fees and finance charges.
Your statement will include the minimum payment and the date it is due. To avoid late fees, you need to pay the minimum before the due date.
Applying for a Credit Card
Credit card issuers make it very easy for you to apply online, at the bank or in the store. You really cannot step out anywhere without someone offering you a special deal if you apply for their credit card. That is partially what makes them so seductive, and so dangerous. Do not ever apply for a credit card on a whim. Make sure you review all the literature about the card, especially the small print in the terms, before making the decision to apply.
Will I be approved?
This is the big question, especially if you are a first time applicant with a sparse credit history or someone who has a less-than-stellar payment history. Whether or not you are approved for a credit card comes down to you creditworthiness.
What is "creditworthiness"?
When you apply for a credit card, you will be evaluated for your creditworthiness, meaning, how risky is it for the issuer to extend credit to you.
The Importance of FICO Scores
Algorithm: (noun) a process or set of rules to be followed in calculations or other problem-solving operations, especially by a computer.
You are only a set of financial data entered into an algorithm. That is why you should never take credit card denial personally. Credit card issuers never deny credit based on personal things like race, sex, or religion. They also never deny credit based on character flaws like sick days taken, parking tickets or overdue library books.
FICO Credit Score
The big three credit bureaus – Equifax, Experian and TransUnion – collect financial information and evaluate a credit score based on a predictive risk algorithm created by the Fair Isaac Corporation aka FICO. Financial institutions pay to access the records and scores from one, two, or all three credit bureaus, and may then further manipulate data using their own algorithms created by underwriters who are constantly assessing how to mitigate the risk the bank takes to issue credit cards.
The records kept by the three credit bureaus may be different and lead to each reporting a different score. The issuers also determine creditworthiness based on what their underwriters determine to be the greatest risk factors to lending, and those change all the time. That is why you should take advantage of getting your credit report from each agency every year.
Breaking Down the FICO Score
These aspects of your credit report determine your score. The percentages are equal to the importance to your score.
Payment history: 40%
- How many times were you late paying bills in your recent past?
- Were there any credit cards that were charged-off (went into default) in your history?
- How often do you use credit?
- How many credit cards to you have?
Length of credit history: 21%
- Do you have no or very little credit history?
- Have you had credit cards 2-5 years?
- Have you had credit cards more than 10 years?
Total balances owing: 11%
- How much do you have owing on your credit cards?
- Are any of your credit cards maxed out?
New credit accounts: 5%
- Have you applied for lots of credit cards lately?
- Have there been many hard pulls on your credit report recently?
FAST FACT: 90% will look at your FICO score
According to myFICO.com, the top US lenders make decisions based on FICO scores 90% of the time.
How does my credit score stack up against others?
In April of this year, fico.com reported that more US consumers had good credit scores than bad ones – a greater number of Americans had scores of 800 and more than had scores of 600 or less. The average FICO score hit a benchmark number of 700. According to the blog, the reasons for rising FICO scores are due to a period of stable economic growth as well as increased FICO score awareness and credit education
Those who scored the lowest (600 or less) had high debt-to-income ratios and lots of recent late payments, but this segment has also continued to shrink.
Here are how the scores look based on FICO.com's April, 2017 data:
The Cost of Credit Cards
Credit card issuers charge interest, usually after a 21-day grace period and a set of fees in exchange for using their cards. Here is an outline of how they work:
These are the fees that are standard in the credit card industry.
Annual fees are rare unless you are applying for a credit card that offers rewards, and those annual fees can range widely from about $40-$500. Even then, you can often find a good rewards card that waives the annual fee for the first year as an incentive.
Cash Advance Fees
Most credit cards charge a fee around 3% on the total amount of cash you withdraw using your credit card.
Balance Transfer Fees
A good reason to apply for a new credit card is to be able to transfer your balance from a card with a high interest rate to one that is lower. However, most credit cards charge a fee of about 3%.
Foreign Transaction Fees
This is a fee charged for every transaction you make outside of the US. It typically is around 3%.
This charge is applied if you spend more than your credit limit.
Late Payment Fees
These fees are around $35, but it's not paying the fee that will hurt you. Late payments will be reported to the credit bureaus and will lower your credit score, not to mention that the bank could raise your APR.
Returned Payment Fees
These are usually similar to late payment fees and have the same results.
FAST FACT: We are getting better at paying bills on time
Only 16.5% of consumers had serious delinquencies (over 90 days) in 2017 – a 3.5% decrease from 2016.
These fees are less popular, but plenty of banks will still charge them.
This is a one-time fee to pay for the bank to review your application and setup your account, I presume. And I say that because no one has a very clear answer on why the bank charges them. Luckily, these fees are falling out of favor as more issuers compete for customers.
Merchant Surcharge Fees
Remember how merchants pay the most in transaction fees whenever they accept a credit card payment? Some will recoup that cost by charging customers a small percentage fee added to their sales total.
Credit Cards: Most & Least Fees
- First Premier Bank credit card
- BankAmericard Secured card
- Blue Sky from American Express
- American Express Hilton HHonors card
- Key Bank's Key2More Rewards
- PenFed Credit Union Promise Visa
- Capital One Platinum
- Capital One Secured MasterCard
- Sam's Club MasterCard
- Capital One SonyCard Visa
If you are like me and it helps to have fee systems explained by someone with a dry-erase marker, then take a look at "Understanding Common Credit Card Fees" by MyBankTracker and let Lindsey Alexander help us out.
Annual Percentage Rate (APR)
Credit card offers and applications often advertise their low Annual Percentage Rate (APR), so you may not look further at the small print and see the compounded interest rates they charge. It can take what at first seems like a good deal and turn it into a cash-sucking nightmare.
The APR is a yearly rate that usually appears as a range on credit card offers. Applicants deemed most creditworthy will receive the lowest rate. According to creditcards.com, the average credit card APR for the end of August, 2017 was 16.14%. As a rule, when you make a minimum payment, it will be applied to the balance with the highest APR.
This is the yearly interest rate you will pay on the balance of your credit card. It can be offered in two ways:
- Fixed APR: This rate stays the same unless you are contacted by the issuer.
- Variable APR: This rate is a reflection of the prime rate and changes when the index does.
Cash Advance APR
According to an article by Tony Mecia published on creditcards.com, most issuers will charge a higher APR for cash advances – around 24% – 6 percentage points more than purchase APR. There is also typically a 3% a fee on top of that.
Balance Transfer APR
Like cash advances, issuers usually charge a higher APR to transfer a balance from another card onto their credit card. This rate can be around 12-18% and you will also be charged a fee of about 3% as well.
Issuers can raise your credit card by 20-35% as a penalty for late payments!! However, there are laws that regulate how penalty APRs work:
To legally incur a penalty APR:
- You must be more than 60 days late paying your credit card bill
- It must be after the first year of opening your credit card account
After the first year of opening your account, the bank can charge a penalty APR for any infraction but:
- They must inform you of the reason for charging you a penalty APR in writing 45 days in advance of it taking effect
- They have to wait two weeks after mailing the notice to begin charging the penalty APR and only on new purchases
- They must lower your APR back to your original rate after six months of consecutively paying your credit card bill on time
I know … it's math. Let's let nationally recognized credit expert John Ulzheimer's video "What Is an APR? – Credit Card Insider" explain it for us.
AVERAGE DAILY CREDIT CARD BALANCE
Most cards charge compound daily interest in the form of a finance charge that slowly raises your balance every day you carry one past the grace period. You then pay interest on your increased balance.
The equation for the average daily credit card balance is the purchase APR divided by the days in the year (365). Here is an example:
Why Do I Need a Credit Card?
You don't necessarily need a credit card, but there are some things – renting a car, purchasing items online – that require one, and, let's face it, they are really convenient. Here are some reasons to apply for a credit card:
Whether it's buying airline tickets, or concert tickets, or ordering clothing from your favorite store, credit cards can make purchasing easier.
Your credit card acts as a deposit on things like car rentals and hotel amenities. They are even required in some situations where you cannot cash qualify.
A credit card is a great way to build your credit by proving that you are financially responsible, by paying your bills on time every month.
A credit card with rewards suited to the way you spend, can really give you great savings and bonuses.
FAST FACT: Rewards cards require good credit
According to Consumer Reports, in order to qualify for the best rewards credit cards on the market, you need to have a credit score of 740 or above.
Credit cards can be really useful when the unexpected happens and you don't have enough cash in the bank to cover it.
You can always cancel a credit card if it is lost or stolen (hopefully) before it is used. If your cash is lost or stolen, you can kiss it goodbye.
What are Personal Loans & When Do You Take One?
Loan: (noun) a thing that is borrowed, especially a sum of money that is expected to be paid back with interest.
What is a Personal Loan?
A personal loan is money that you borrow from a lender such as a bank, credit union, private lenders or peer-to-peer lenders. When you apply for a personal loan, you request a total amount and, if you are approved, the lender will deposit into your account. The loan is paid off in monthly installments for the term of the loan (typically 2-5 years). Each monthly payment will include both the principal and the interest.
FAST FACT: Unsecured vs. Secured Loans
Personal loans are considered "unsecured" because borrowers are not asked to use collateral to guarantee the debt will be paid back. Secured loans like car loans and mortgages are guaranteed by the borrower's automobile or home, and therefore have lower interest rates. However, if you do not repay a secured loan, the bank can repossess your car and foreclose on your home.
Kinds of Lenders
To borrow money by traditional means, you would visit a bank or credit union. Private lenders are more unconventional and P2P lending is a newer, technology-based solution.
Banks are traditional lenders and it can be easier to secure a personal loan from a financial institution where you already have open accounts.
Top 5 Biggest American Banks Ranked by Assets
- JPMorgan Chase & Co.: $2.55 trillion
- Bank of America Corp.: $2.25 trillion
- Wells Fargo & Co.: $1.95 trillion
- Citigroup Inc.: $1.82 trillion
- Goldman Sachs Group Inc.: $894.09 billion
Credit unions are owned by the customers (members) who bank there. They provide all the financial products that banks do, but because they are cooperatives, they can offer more reasonable rates.
Top 5 Biggest American Credit Unions by Assets
- Navy Federal Credit Union: $55.5 billion
- State Employees Credit Union: $28.3 billion
- PenFed Federal Credit Union: $17.6 billion
- BECU: $12.6 billion
- SchoolsFirst Federal Credit Union: $10.3 billion
FAST FACT: Credit unions have loans for poor credit
"Many credit unions have alternative programs that provide loans at low prices to people with poor credit scores. Additionally, credit unions are not-for-profit entities, so they may be able to charge lower interest rates than other banks." — Diane Moogalian, VP of operations for Equifax Personal Solutions
Peer-to-peer (P2P) Fintech (Non Bank Online Lenders)
These are companies that supply financial products but are not banks or credit unions. P2P companies are the online portal that brings borrowers and lenders together. The largest P2P lender is Lending Club, others include SoFi, Upstart, Earnest, and Affirm. These lenders have been gaining more of the personal loan market forcing all lenders to be more competitive. That is great for borrowers.
fintech: (noun) computer programs and other technology used to support or enable banking and financial services.
Experian illustrated this recently with their data showing the increasing strength of fintech lenders.
Let's learn more about how it works with this short video "What is Fintech?" by David Bruno, Fintech expert and podcast host at The #MakerZone.
How Do Personal Loans Work?
A personal loan is exactly what it sounds like – a lender provides you with a set amount of money (more than $1,000 and less than $50,000) that you agree to pay back with interest in monthly installments for the term of the loan.
FAST FACT: Payday loans are NOT personal loans
These short-term loans usually cap at $500 and are extremely expensive to borrowers. The loans are essentially meant to tide you over until your next payday. The fees can range from 10-30% which translates to almost 400% APR.
Applying for a Personal Loan
The first thing you should do before applying for a personal loan is to research and compare the loans available to you, but I will cover that later on. Now, let's look at loan eligibility and the application process.
Different lenders will have their own set of qualifications they review, but here is a standard eligibility criteria.
Just like credit card issuers, lenders will evaluate your creditworthiness using your credit score. The main areas that lenders will review are your payment history and the total amount you owe. This will allow them to calculate your debt-to-income ratio to see if you can afford to pay off your loan as well as everything else outstanding.
FICO Score Requirements
The higher your credit rating, the lower your interest rates will be on a personal loan.
Note how Wells Fargo doesn't even offer loans to anyone with a credit score below 621 and how the APR rises incrementally as the credit scores get lower.
Unlike credit cards, lenders have an array of information they will use in their loan decision-making, like employment history, job position, what the loan is for, education, sometimes even your grade-point average, can all be considerations. They can also check your bank accounts. Just like credit cards, lenders are weighing how much risk they are taking by approving a personal loan and have a whole matrix of points to help them decide.
The Cost of Personal Loans
Don't take out a personal loan if you can't afford it. That seems like it would be obvious, but sometimes it isn't. Before you apply, do the math. I will even help you with a link to our personal loan calculator.
Application Fee Some lenders charge this nonrefundable fee to cover the cost of reviewing your application and processing it through the decision-tree.
Origination Fees This fee is a 1-5% charge of the total loan amount. It is another charge that can sneak in there and be added to your loan balance on which you will also be paying interest.
Late Payment Fees If your monthly payment is late, you can expect to pay a penalty fee up to $40 or 4-5% of your installment amount.
Returned Payment Fees Just like when you bounce a check anywhere, your lender will apply Non-Sufficient Funds (NSF) charges on a returned payments. If your lender is not your bank, you can expect a bank charge as well.
Check Processing Fees I haven't used a check in years for exactly reasons like this. Some lenders will charge around $7 for check payment processing
Exit Fees Lenders can charge you for paying off your loan early to recoup the costs of the lost interest.
Personal Loan APRs
Here is a look at typical APRs by loan amount and term:
When Should I Apply for a Personal Loan?
There are some really good reasons to apply for a personal loan. Here are a few:
This is one of the main reasons many apply for personal loans. If you have balances owing to several different cards, you can get a loan to pay them all off and then only have one monthly installment to pay.
Here is a really informative short animated video called "How Debt Consolidation Works" by DebtConsolidation.com. Don't feel like you have to be as thrilled about debt consolidation as the main character.
One-time Emergency Expense
If you have been avoiding that new roof you know you need because you cannot afford it, a personal loan can help you get it done and pay for it over time.
Big Ticket Items
Need a new refrigerator? Washing machine? A personal loan can cover the cost of the more expensive items you need but do not have the cash upfront to purchase.
This one is iffy. I am including it here for the simple reason that there are some medical bills that cannot be paid any other way, but I hesitate because you should fully explore the flexibility offered by hospitals and clinics. They often have payment plans available for less interest than a personal loan.
When Should I Not Apply for a Personal Loan
There are also some really good reasons NOT to apply for a personal loan. I have included them here.
Don't get a personal loan to buy a car. Lenders have a whole other loan deal for cars.
Like cars, there are lots of other available loans for education that have better interest rates than personal loans.
You just never know how things will turn out. The term of the loan could last longer than your marriage. I know I am being unromantic, but I would rather take a loan for a trip together than a wedding. However, I am not suggesting you take out a personal loan for a trip, but that is up to you.
FAST FACT: Weddings are REALLY expensive
The average cost of a wedding is somewhere between $20,000-$33,000, and that doesn't include the honeymoon!
Even though I have advised against taking out a personal loan for cars and education, many people do it. Finder.com and research firm Pureprofile, surveyed borrowers to see the top reasons for applying for personal loans. Here are the results:
Now that we have covered the basics on credit cards and personal loans, let's move on to compare the pros and cons of each.
Understanding the Pros & Cons
Pros and cons: (plural noun) the favorable and the unfavorable factors or reasons; advantages and disadvantages
Now that we have delved into the fundamentals of credit cards and personal loans, we can move forward to contrasting the positives and negatives of each.
When you take out a personal loan, everything is fixed – the APR, the term and the monthly payment amount. You know exactly how much you owe every month and can be prepared to pay it. That is a plus.
A personal loan can be used for anything you want. You can use part of it to pay off a credit card and the rest for a new bathroom floor, or whatever and however you choose to spend it.
If you have good to excellent credit, that is.
No Property Risk
If you default on your loan, it will go to collections and ruin your credit rating, but your home and car are safe.
Good Credit Score Required
You probably won't qualify for a personal loan if your FICO score is low. Most lenders will ask you to repair your credit and reapply later.
Paying 1-5% on the total amount of the loan could be a significant amount to repay if you borrow enough.
Lenders may charge you for the interest they lose if you pay your loan off early.
Credit cards make paying for anything – gas, airline tickets, dinner – really easy.
A credit card is immediate access to funds when you desperately need it.
Build or Rebuild Credit
Paying your minimum on time every month can boost the health of your credit score.
Most credit cards offer incentives like 6-months 0% APR or waiving the annual fee for the first year.
You can find a credit card with rewards that suit your lifestyle, like travel points, cash back, savings and bonuses.
Does Not Require Good Credit
There are credit cards available for those with bad credit or no credit history, however the interest rate will be significantly higher.
If you don't pay your balance off every month, you are paying significant interest rates.
Credit cards charge lots of fees with some hidden in the small print.
Average Daily Credit Card Balance
Charging a finance fee daily that increases your balance and applicable interest rate.
Easy To Spend More
"Buy now, pay later" psychology can put you into debt.
FAST FACT: We overspend when we use credit cards
Psychological research has shown that we will often pay more for a product when we use our credit cards than when we pay with cash.
How To Use Credit Cards & Loans for Maximum Impact
Maximum: (adjective) greatest or highest possible or attained
Before Applying for a Credit Card
What to Look For
You want a credit card that will benefit you the most in the way you spend money. That means that if you use a credit card to travel, you need to compare the best travel credit cards available. If you use a credit card to buy your groceries, look for a card that offers extra points or cash back on those purchases.
These are other considerations:
Try to get the best APR for your credit card.
Look for a card with a limit high enough that you are not in danger of maxing it out.
No Annual Fees
There are lots of credit cards that do not charge annual fees. If you are paying an annual fee, you should have great rewards. Otherwise, contact your issuer and ask them to waive the annual fee or if you can switch to a different card without an annual fee.
Rewards Fine Print
If you are looking for a rewards credit card, make sure you read the fine print about the rewards program. This may not be on the application so make sure you do your research first. There are a few tricks that companies may use and you will be disappointed if the rewards are not what you signed up for.
According to Consumer Reports, these are the tricky ways credit card companies save money on rewards programs:
Offering cashback on products based during the season they are most popular with consumers, but capping how many points you can earn.
Requiring a minimum amount of spending on the credit card before you can reap the rewards benefits.
Changing cashback rewards after you have reached a set amount, i.e. offering a higher percentage back on groceries until you have spent $1,000 and then dropping the percentage significantly after.
Wiping out all your points after a certain amount of time.
Late Payment Penalties
Deducting your points when you are late paying your bill and then charging a fee to reinstate them.
Credit Cards: Maximize the Value
You can't really expect to defeat a card shark on the street or beat the house at a casino, but you can regularly win big with your credit cards. The key is that banks are intensely competing for your business, which will always be your ace in the hole.
Transfer Your Balance to a Card with a Lower APR
The most obvious and popular way to save money on your credit card is by transferring your balance to a new card that carries less interest. Often you can find cards that offer a balance transfer of 0% APR sign-up bonus for a certain amount of time – anywhere from 3-21 months.
- $500 Balance
- 18% APR
- $866.66 Monthly Payment
If you transfer your balance to a credit card with a 0% APR for the first 21 months:
- $500 Balance
- 0% APR
- $416.66 Monthly Payment
However, do not use a balance transfer as a way to fall further into debt. The goal should always be to pay the card off completely, and a balance transfer can help you do that.
Here is a cool little Q&A video from British journalist and editor at MoneySavingExpert.com, Martin Lewis on balance transfers.
The Secret to Sign-Up Bonuses
Introductory 0% APR
Have your big ticket item in mind before you apply for credit cards with this incentive. Many companies offer a 0% APR for purchases made during your first six months of opening the account.
Apply for Two Cards
If the sign-up bonus is really great, apply for a personal and business cards to get twice the benefits. Just don't spend twice as much.
Travel Rewards Cards
Plan to travel? Find a credit card that offers great travel point bonuses or free hotel stays. The credit card company may require a minimum spending amount to enjoy these incentives, but if you were planning to use the card for a vacation anyway, the points and freebies can help you save big.
Buy Gift Cards to Reach Spending Minimum on Sign-Up Bonuses Purchase gift cards from the stores you regularly shop in or buy cash cards before the promotional sign-up bonus period on your new credit card expires. If your card offers extra points on things like gas and groceries, buy gift cards from those retailers during the promotional period, and use them instead of cash at any time later.
FAST FACT: 31% have never redeemed rewards
About 3 out of 10 credit cardholders have never used their points for rewards!
Credit Card Stacking
Amanda Walker's recent Consumer Reports' article How to Cash In on Cash-Back Credit Cards offers insight into how credit card stacking can save cardholders loads of money. Credit card stacking is the practice of using several card strategically to maximize their benefits.
Using cash-back cards, cardholders are refunded 1-6% on their spending by statement credit, bank transfer or check. Walker created spending scenarios based on data from the Bureau of Labor Statistics and then illustrated how credit card stacking could earn up to 40% more cash-back benefits.
What you need to stack credit cards
- Cards with:
- Generous sign-up bonuses
- Cash-back rewards
- Zero balances on existing cards
- Credit good enough to be approved for credit cards offering cash-back rewards
Investigate your spending habits in order to find out monthly spending totals on gas, groceries, restaurants, travel and a category for "everything else". Find what percentage of your spending goes into these categories. Here is a sample spending scenarios using credit card stacking presented by Walker:
Single Female Professional
Typical monthly charges: $1,800
Credit Card Strategy
Walker suggests that by using this credit card combo, the cardholder can earn $1,600 cash back within three years:
- For restaurants and entertainment: Use the HSBC Advance Mastercard which offers 2 points per $1 spent, each point = 1 cent.
- All other spending: Use the PenFed Power Cash Rewards Visa which offers unlimited 2% cash-back.
In another spending scenario, Walker shows how a large family that spends 22% of their monthly $3,500 spending on groceries can save a bundle by using the American Express Blue Cash Preferred credit card to earn 6% cash back on groceries up to $6,000 per year.
FAST FACT: Millions don't take advantage of new card offers
20 million cardholders still use their original preferred credit card, 25 million more haven't changed their credit card in over 10 years.
Credit Card Churning
This is the practice of applying for a credit card only for its sign-up bonus and then cancelling the card when the bonus period expires. Recently, issuers have become more savvy about applicants who are credit card churning and have taken action like putting limitations on how often you can apply for sign-up bonuses, or even blacklisting you from applying for cards in the future.
According to Chloe Della Costa in her article How to Game the System to Maximize Credit Card Rewards, you can get around punitive responses to credit card churning by keeping your account open after receiving the sign-up bonus, but only if there is no annual fee.
Everyday Tricks to Save Money
Redeem Points for Gift Cards instead of Cash
Most credit card rewards include store and product partners that you can purchase gift cards from with your points, and usually your points are worth more this way.
Use Cash Back Credit Card for Everything
You can hit the ceiling of cash back offers by paying for all your expenses using your credit card and then paying off the balance using the money you would have spent on those bills. It also helps your credit rating to pay bills automatically using your credit card. For example, the Citi Double Cash Card offers 1% cashback on your purchase and another 1% when you pay it off. Every month, you could make 2% back just by paying your bills.
Check Car Rental Benefits
If you decline car rental insurance and use your credit card to rent a car, most cards will cover the insurance for you. That could mean big savings.
Get Refunds with Price Protection
If your credit card offers price protection, then they will refund you the difference if you make a purchase and you discover it has been marked down. Some cards will even let you know that your purchase has been offered for a cheaper price, but if your program works where you have to submit receipts, I recommend using the following websites and apps to track price changes:
- Offers.com: Tracks prices of about 10,000 brands and stores
- CamelCamelCamel: Tracks Amazon purchases and alerts you through email, Twitter, or RSS feed.
- SlickDeals Price Tracker: Tracks Amazon, Newegg, Gamestop, IKEA, Buy.com products as well as others
- PriceZombie: Tracks Amazon, Newegg, Target, TigerDirect, Fry's, IKEA, HomeDepot products as well as others. Also has a browser add-on and tracks price drops in real-time.
Make sure you check the exclusions on price protection. You cannot use it for perishable items and most credit cards will also not refund purchases of art, antiques, jewellery, or motorized vehicles. There are also spending amount and time limits, so make sure you understand the regulations in order to benefit from price protection.
Use your Extended Warranty
Check to see if there is an extended warranty benefit on your credit card. If so, use it to buy items that need one, like electronics and you can refuse the manufacturer's extended warranty which can be pricey. If anything breaks down, you can easily have it repaired or replaced by submitting the receipt to the credit card company.
Use Co-Branded Cards on Discount Days
Some retailers offer discount days to cardholders where you can get significant savings on your purchases. Wait to buy from your favourite stores on these days for the best deals.
Buy Extra Interest-Free Time If you make a purchase the day after your monthly credit card statement closes, you can add about another month interest free grace period before you have to pay for it.
Let's say your credit card billing cycle is 35 days and let's say your last transaction statement closed September 1st. The next billing cycle will start October 5th. If you made a purchase on September 2nd, you would not be charged interest on it until November 7th. That is 66 days interest-free.
Before Applying for a Personal Loan
What to Look For
Most people who apply for a personal loan have already established how they plan to use it and have a loan amount in mind before they make the application, but where they will get the best interest rate, lowest fees and most flexible terms is the real question. To find out, do a little research and compare the different kinds of lenders to find out the best loans for you.
Compare interest rates of different lenders, but see if there are lower rates based on loan term or amount.
Some lenders don't charge fees other than interest; others may charge origination fees, late payment fees, or prepayment fees. If fees are present, they must not be significantly higher than its competitors'.
Though you want to be careful not to borrow more than you can afford, the best lenders won't cap their loans at low amounts, letting you borrow what you need.
Some lenders only allow you to pick from a couple of terms, such as three or five years. Others, however, allow more flexibility in shorter or longer loan terms and can better accommodate various borrower needs.
Consider Peer-to-peer Lending
If you are having trouble getting a loan from a traditional lender, check out what P2P lenders can offer you. There are some that will provide loans for those with poor and no credit, with interest rates lower than credit cards.
Personal Loans: Maximize the Value
Fix your Credit Score Before Applying
Those with the best credit ratings will be offered loans with the lowest interest rates. It could be worthwhile to use an extra funds you have to pay down or off any bad credit you have to increase your credit score before you apply for a personal loan so you can get the best interest rates available.
Never Lie About Income
It is never advisable to lie about your income in order to secure a higher loan amount. If you are caught, your loan will be cancelled or put into immediate default, not to mental that misrepresenting yourself on a loan application is illegal. It could destroy your credit score.
FAST FACT: It doesn't pay to lie on loan applications
For a 7 year period, Prosper Marketplace cancelled 12% of approved loans due to inaccurate or insufficient information.
Pay Off High Interest Credit Cards
One of the best ways to use a personal loan is to pay off a credit card with a high interest rate. This can totally dig you out of debt hole if you do not begin making purchases on the same card again. That would just make things worse.
Pay Off Other High Interest Debt
If you have high interest debt owing for household and electronic purchases to stores, a personal loan could save you money.
Shorter term loans have a lower interest rate. You could even take out another short-term loan again after you pay off the first.
Make More Payments
When you make payments more frequently the once per month, you will pay less interest in the long run. If you will not be charged an exit fee, cut your monthly payment in half and pay that amount on the loan every other week. This allows you to pay more back in one year than if you pay monthly.
If you pay $79.86 bi-monthly, in one year you will have paid $2,076.36. Your loan will be paid off in just over 1.5 years, saving you $375 in interest.
Pay Off Your Loan Early
I have two brothers both named Darryl and one of them is not very financially savvy. Here is an example of how I maximized my savings on interest by doubling my monthly payments on my personal loan.
Both Darryl and I took out personal loans of $10,000 at 20% APR with a 10-year period to pay it back. Under these terms, the monthly payment would be $200. I decided to double that amount to save money on interest payments. Darryl decided to stay with the $200 monthly payment. So here is a chart to show you the difference between how Darryl and I approached repaying our loans.
|Personal loan terms||$10,000, 20% APR, 10 years||$10,000, 20% APR, 10 years|
|Amount to balance||$160||$320|
|Amount to interest||$40||$80|
Here is how things worked out with each of our chosen monthly payments.
|Time it took to pay back loan||9.4 years||2.72 years|
|Total interest paid||$11,679.80||$3,043.42|
|Total Dan saved||$8,636.38|
Even if you don't double your payment, but just add $100 extra every month will result in significant savings. Here's an example:
- $5,000 Loan Amount
- 15% APR
- 5-Year Term
This will result in the following:
|Monthly payments||Total interest paid||You save|
The Verdict: Which One Wins?
Credit Cards vs. Personal Loans
It is a bit like comparing apples to oranges to measure a credit card against a personal loan because ideally you should be using them in different ways.
|Credit Card||Personal Loan|
|Reasons to apply||Build or rebuild credit Balance transfer to a card with lower APR Rewards Emergencies Convenience Travel security||Build or rebuild credit Debt consolidation Pay off credit card debt Need access to funds for expensive items or services that you do not have cash upfront for like home repairs/renovations, appliances, medical bills, etc.|
|Kind of Credit||Revolving: Continuously using card for purchases and paying it off||Fixed: Set amount paid down in monthly installments for a certain term|
|Interest Charged||Pay 0 interest if balance is paid during grace period||Interest is rolled into monthly payment|
|Payments||Can pay a minimum, but will accrue interest and fees||Must pay fixed amount every month|
|FICO Score Needed||Can qualify for some cards with low score, but generally with high APR||Generally will not qualify for a bank loan with low score, but credit unions and P2P lenders may approve more easily|
|Fees to Avoid||Annual fee Balance transfer fees Penalty APR||Origination fee Exit fee|
|Find a Credit Card||Get a Loan|
So, which one wins? That all comes down to you and what you can afford. If you tend to overspend, but like the convenience and security of a credit card, get a secured one. If you are responsible with your payments and budget well and love rewards, apply for a top rewards card. If you need $10,000 worth of repairs on your home and have made the calculations to be sure you can make the monthly payments, apply for a personal loan. If you have sketchy credit, but really need a few grand for a new washer and dryer, try a P2P lender or credit union to get a loan.
Having said that, if applying for either of these financial products ends up destroying your credit rating and hurling you into further debt, then you are the one that loses.
Loose Ends: Things You Must Know About Both
Here is the straight truth: successfully using credit cards or personal loans comes from complete honesty and self-awareness about your spending habits and financial goals.
Time to look at yourself
- Will I pay off a credit card balance every month?
- Do I have enough monthly income to pay a fixed amount towards a personal loan?
- If I use a personal loan to pay off a credit card, will I have the willpower to avoid maxing it out again?
- Do I often pay my bills late?
- Do I feel like I need to have the next new thing on the market?
These are the right kinds of questions to ask yourself before applying for credit cards and personal loans. I know it may hurt, but certainly not as much as constantly being in debt.
On Credit Cards
Without an annual fee, using a credit card is free as you pay off your balance monthly.
On Personal Loans
Make lenders compete for your business by comparing their personal loans and find one with the lowest APR, no origination fees and flexible terms.