The world of finance is full of terms and concepts that can be unfamiliar to the average person. Yet failing to understand important financial concepts could cause you a number of problems. According to a financial anxiety study by the FINRA Foundation, people with high financial literacy were less likely to feel anxious about their money than those who didn’t have a firm grasp on important money topics such as interest rates and inflation.
When it comes to your money, what you don’t know might hurt you. There’s no shame in being confused about financial concepts. But it is important to try to learn more about the money- and credit-related subjects you don’t understand.
The cheat sheet below can be a great place to start, highlighting eight basic financial services and credit card concepts you’ll want to know.
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What is debt?
When you borrow money from a lender or credit card company, the amount you owe is called a debt. Debt is a sum of money that you borrow from another party and promise to repay later — typically with interest.
If you commit to managing your debts responsibly, you may be able to use the money you borrow to enhance your life in numerous ways. For instance, you might take out a loan to earn a college degree, start a business or purchase a home. These are examples of what many financial experts would consider to be “good” debts. You can also use credit cards to earn rewards and enjoy other benefits without paying interest if you pay off your full statement balance every month.
Yet it’s easy to let debt get out of hand and overextend yourself financially if you’re not careful. Imagine you max out your credit card limit on frivolous spending or take out a personal loan to finance a lavish vacation. In such scenarios, debt can become a burden.
How can you avoid debt?
A budget is the best tool you can use to avoid going into “bad” debt. When you use a budget, it helps you make a plan for your money to make sure that your spending matches your priorities.
Once you set a budget, it’s important to monitor your spending to make sure you follow the plan. The good news is that there are many apps that make managing your finances easier, including tools to help you keep track of multiple credit cards.
If you know you have large expenses coming up, such as a wedding, down payment or vacation, you can use your budget to save for those costs in advance. Planning ahead can help you afford the things that matter to you while avoiding debt. (Tip: Taking advantage of credit card rewards and generous sign-up bonuses can help you reach your travel-related savings goals faster.)
What is interest?
There are two types of interest: interest you earn and interest you pay. On the borrowing side, interest is the price you pay to a lender or credit card company to borrow money. In this context, you’ll often see interest expressed as an annual percentage rate, or APR. When it comes to financing on products like credit cards, you’ll want to secure the lowest interest rate possible.
You can also earn interest on the money you keep in a deposit account with a bank or credit union. A financial institution may express the interest you earn as your annual percentage yield, or APY. If you’re earning money on the cash you deposit with a bank or credit union, you’ll want to aim for the highest APY possible to grow your savings.
Some examples of accounts where you might deposit money and earn interest in return are as follows:
- Savings accounts.
- Checking accounts.
- Certificates of deposit.
- Money market accounts.
Are credit cards bad?
Credit cards are not inherently good or bad. Rather, the choices you make as a cardholder determine whether these financial tools may improve or damage your finances and credit.
If you make wise decisions when it comes to credit card management, credit cards have the potential to offer numerous perks and benefits such as:
- The potential to build good credit.
- Credit card rewards (points, miles or cash back).
- Statement credits such as travel credits.
- Airport lounge access.
- Fraud protections.
Is it better to have a debit or credit card?
If you use debit cards instead of credit cards as your preferred payment method, you could be missing out on many of the benefits above. Most notably, debit cards cannot help you build credit history nor do they contribute to your credit score.
Debit cards also lack some of the robust fraud protections that credit cards offer.
The Electronic Fund Transfer Act caps your liability for fraudulent debit card transactions at $500. However, if you report the fraud within two business days, your liability is only $50. Your personal money may also be tied up while the bank investigates unauthorized charges that took place on your debit card. That complication might cause serious financial challenges if you have other bills due before the bank returns your funds.
Credit cards, on the other hand, limit your liability for fraudulent transactions to $50, provided you report unauthorized charges within 60 days. This is thanks to the Fair Credit Billing Act. What’s more, the four major credit card networks currently waive the $50 cost as a courtesy. Also, if someone uses your credit card without permission and you report the fraudulent transaction, the card issuer won’t hold up your personal funds during the investigation process.
How many credit cards are too many?
There’s no magic number of credit cards that you should keep in your wallet. Some people are able to manage a couple of credit card accounts responsibly and maintain good credit scores at the same time. Others can handle dozens of credit card accounts with success.
The right number of credit cards for you may be different from what works for the next person. As a rule, only open as many credit cards as you feel comfortable managing — with the goal of paying your entire statement balance off on every account each month.
Will too many credit cards hurt my score?
Credit scoring models don’t pay much attention to the number of credit cards on your credit report. Instead, the credit score factors that are more likely to affect you are:
- Payment history.
- Credit utilization ratio.
- Number of accounts carrying a balance.
Our advice is to stay consistent in paying your credit cards on time and therefore keep your balance-to-limit rates (or credit utilization ratio) low. If you follow these rules, you should be off to a good start in the credit score department — provided there aren’t other problems on your credit report. You could also consider paying your credit card balances early to potentially boost your credit score in some situations.
Finally, pay attention to how often you apply for new credit like credit cards and loans. An excessive number of hard credit inquiries might hurt your credit score — though if you do experience an inquiry-related credit score decline, it might not be that serious. According to FICO, an additional hard credit inquiry takes fewer than five points away from most people’s FICO Score.
Does canceling a credit card hurt your credit score?
Some people make the incorrect assumption that canceling a credit card will improve their credit score. In reality, closing a credit card might actually negatively affect your credit score.
When you close a credit card, there’s a chance you could trigger an increase in your overall credit utilization ratio. If the ratio goes up on your credit report, your credit score might slide downward.
There are ways to keep your credit score safe when canceling a credit card. So, if there’s an important reason you need to close a credit card account, check out this TPG guide for tips on how to navigate the process.
Learning the basic financial services and credit card concepts above can help you in many ways. As you understand more about money and financing, you’ll be better prepared to make wise financial moves that can benefit you for years to come.
Use the right card and maximize your rewards on everyday purchases. Try it today with the free TPG App.