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What You Should Know Before Getting Your First Credit Card

Bill Hardekopf

Obtaining your first credit card can be a daunting task. After all, there are hundreds of credit cards on the market, as well as countless horror stories about misusing them. If you are taking the initial step to apply for a card, you should know what you're getting into so you can guard against rookie mistakes.

Four Things to Know Before You Open a Credit Card Account

You should have at least a basic understanding of how credit cards work before you apply for one. Key concepts include:

-- Borrowing money with credit cards.

-- How interest applies.

-- Credit card terms and conditions.

-- Applying for a card.

[Read: Best Starter Credit Cards.]

Borrowing money with credit cards. Although they are similar in appearance, a debit card is quite different from a credit card. When you make a purchase with a debit card, the money is coming directly from your checking account and you're not borrowing any money. If you don't have the adequate funds in your account, your debit card transaction will be denied.

But when you make a transaction with a credit card, you are using the bank's money, not your own. The bank is taking a risk that you will repay the balance because, unless you're using a secured credit card, you don't have to put up any collateral to get the loan. It's not like secured loans for your house or car, where your property can be repossessed for nonpayment.

If you don't pay back the balance on your credit card, the bank can't repossess your purchases. So the loan that a credit card issuer makes is a much greater risk than a secured loan. That is why credit cards usually have a much higher interest rate than secured loans.

How interest applies. If you repay your credit card balance in full and on time each month, you will essentially be using the bank's money for free since you will not incur any interest charges. However, if you carry a balance from one month to the next, you will be charged interest on the balance according to your card's annual percentage rate. Typically, credit cards have an average APR of 17 to 24 percent, according to U.S. News data.

Credit card terms and conditions. When applying for a credit card, take time to read the fine print in the terms and conditions.

"It's important to read these terms," says Erik Paquet, editor-in-chief of AwardWallet, which helps consumers track their loyalty points and miles. "A credit card agreement is a contract and like any contract, it is binding. It will spell out everything you as a cardholder are responsible for in this relationship."

The terms and conditions contain important information you agree to when you use the card, not just the promotional copy that sounds so inviting. You will find information about the card's APR range, its applicable fees, how rewards work and other details surrounding cardholder benefits.

Applying for a card. The types of cards for which you may be approved and the interest rate you will be charged will depend on your credit score, so it's important to know where you stand before applying. If you have poor or no credit, it's pointless to apply for a card that requires good or excellent credit. On the other hand, if you build your credit, you will eventually have a wider selection of cards to choose from and receive a more attractive interest rate than consumers with a lower credit rating.

It's usually not a good idea to apply for multiple cards at one time because applying for lots of new credit at once can temporarily ding your credit score.

"Putting in several credit card applications at once raises red flags in the underwriting process," says Pete Klipa, senior vice president of creditor relations with the National Foundation for Credit Counseling. "It may give the appearance you have overextended yourself."

Look for credit cards that offer preapproval, which can give you an idea of whether you'll be approved with just a soft credit check that doesn't affect your credit score. Then, apply for one or two cards you're reasonably sure you'll be approved for. If you're turned down, or receive a higher rate or lower credit limit than expected, get a copy of your credit report to see if there are issues you need to correct.

How to Analyze a Credit Card Offer

When applying for a credit card, answer these questions:

What rate will I receive? You may not qualify for the lowest advertised interest rate, so look at the range of APRs offered by the card. Your APR will be determined by your risk, which is mostly based on your credit score.

Will I receive any rewards for using this card? Many cards come with some type of reward or incentive to use your card. These rewards are only profitable if you pay off your card in full and on time, so don't be lured into spending more than you can afford. But if you don't carry a balance, then using a credit card to make your purchases can pay off. So compare the rewards offered by the cards you are considering.

[Read: Best Student Credit Cards.]

Is there a sign-up bonus? Rewards credit cards may offer accelerated rewards to earn new customers. The credit card industry is extremely competitive and issuers are fighting for your business. Some offer an incentive of extra cash, miles or points if you spend a certain amount of money during the first three months of being a cardholder.

Is there an introductory offer on the card? Many cards offer new cardholders a zero percent APR period for purchases, balance transfers or both. These offers can be beneficial, but make sure you can pay off your entire balance before the introductory period ends.

How long is the grace period? The grace period is the interest-free period that a lender gives to credit card holders. It extends from the end of the billing cycle to the payment due date, if no balance is carried over from the previous billing cycle. The longer the grace period, the longer you don't have to pay interest on charges. For cards that offer a grace period, it must last at least 21 days.

Is there an annual fee? Cards with annual fees may offer value if you can take advantage of rewards and benefits. But many cards are available without an annual fee, so you should consider whether the value outweighs the cost.

How to Use a Credit Card Wisely

Follow these basic rules for credit card use to avoid the worst of debt and late payments:

Aim to never charge more on your credit card than you can pay back in full at the end of the month. You may want to set your own limit on how much to spend each month based on what you can afford to pay when the bill is due. When you fail to pay your entire month's statement balance in full, you will incur interest charges. By paying each month's statement balance, you can avoid interest charges.

Keep a low level of debt at the most. If you're not able to pay your credit card bill in full each statement period, not all is lost. But it's still important to exercise caution. Just because you have a credit limit doesn't mean you should spend that amount of money. In fact, experts say you should not use more than 30 percent of your available balance. Keeping your debt in check will also help increase your credit score.

Always make payments on time. If you are late on a payment, you will be assessed a late fee and may be subject to other penalties, depending on your level of delinquency. Your credit score is likely to drop if your payment is more than 30 days late and reported to the credit bureaus, since one of the most important factors in your credit score is your payment history. Conversely, when you make all your credit card payments on time, your credit score should rise as you prove your trustworthiness. To ensure you make all of your payments on time, set up email or text reminders for your payment due date. You can also set up automatic monthly payments.

[Read: Best Secured Credit Cards.]

If You Get Turned Down

As a new credit card consumer, you may not have much credit history, and that can limit the cards you'll be approved for. If you're facing rejection, there are several other options available to you:

-- Apply for a credit card that allows for a lower credit score or a card that is specifically designed for people with no or limited credit history.

-- Ask your bank or credit union about available credit cards. If you have a checking account, then you already have a history with your financial institution, so it may be more likely to offer you a credit card.

-- Get a secured credit card. These cards work just like a standard credit card, except they require the payment of a refundable security deposit before an account can be opened. That deposit typically acts as your credit limit. Cardholders must make at least the minimum payment each month and will incur interest charges unless they pay their entire statement balance in full. Most importantly, a secured card may report your payment history to the three major consumer credit bureaus, allowing you to build your credit when you manage your account responsibly. As you build a history of making on-time payments, you may qualify for an unsecured credit card.

-- Consider student credit cards. There are several cards that are marketed just for college students. They may have lower credit limits and higher interest rates than general cards, but they do enable college students to enter the credit card market and start building a credit history.

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