The world of finance is full of terms and concepts that may be unfamiliar to the average person. However, not understanding key financial concepts can lead to a number of problems. According to a Financial Anxiety Study by the FINRA Foundation, people with high levels of financial literacy were less anxious about their money than people who didn’t have a firm handle on important money issues like interest rates and inflation.
When it comes to your money, what you don’t know can hurt you. There is no shame in being confused about financial concepts. But it’s important that you try to learn more about money and credit topics that you don’t understand.
The following cheat sheet can be a good place to start, highlighting eight basic financial services and credit card concepts you should know.
What are debts?
When you borrow money from a lender or credit card company, the amount owed is called a debt. Debt is a sum of money that you borrow from another party and promise to pay back later, usually with interest.
If you commit to managing your debt responsibly, you may be able to use the money you borrow to improve your life in a variety of ways. For example, you could take out a loan to earn a college degree, start a business, or buy a home. These are examples of what many financial experts would call “good” debt. You can also use credit cards to earn bonuses and enjoy other benefits without paying interest if you pay your entire billing balance each month.
However, it’s easy to get out of debt and financially overwhelmed if you’re not careful. Imagine maxing out your credit card limit with frivolous spending or taking out a personal loan to fund 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 getting into “bad” debt. When you use a budget, it helps you create a plan for your money to make sure your spending stays in line with your priorities.
Once you’ve set a budget, it’s important to monitor your spending to make sure you’re following the plan. The good news is that there are many apps to make managing your finances easier, including tools to help you keep track of multiple credit cards.
If you know you have big expenses like a wedding, down payment, or vacation coming up, you can use your budget to save on those expenses upfront. Planning ahead can help you afford the things you care about 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.)
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What is interest?
There are two types of interest: interest you earn and interest you pay. On the borrower side, interest is the price you pay to a lender or credit card company to borrow money. In this context, you often see interest rates expressed as APR or APR. When it comes to financing products like credit cards, you want to secure the lowest possible interest rate.
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 return, or APY. If you’re making money from the cash you deposit at a bank or credit union, you should aim for the highest APY possible to increase your savings.
Some examples of accounts where you can deposit money and earn interest on it are as follows:
- savings accounts.
- verify 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 instruments can make or break your finances and creditworthiness.
If you make wise decisions about credit card management, credit cards have the potential to offer numerous perks and benefits, such as:
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 miss out on many of the benefits mentioned above. Most importantly, debit cards cannot help you build a 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 limits your liability for fraudulent debit card transactions to $500. However, if you report the scam within two business days, your liability is only $50. Your personal money can also be tied up while the bank investigates unauthorized charges on your debit card. This complication can create serious financial challenges if other bills are due before the bank returns your money.
Credit cards, on the other hand, limit your liability for fraudulent transactions to $50 if you report unauthorized charges within 60 days. This is thanks to the Fair Credit Billing Act. Additionally, the four major credit card networks are currently waiving the $50 cost as a courtesy. If someone uses your credit card without permission and you report the fraudulent transaction, the card issuer will not withhold your personal funds during the investigation.
How many credit cards are too many?
There is no magic number of credit cards to keep in your wallet. Some people are able to manage a few credit card accounts responsibly while maintaining good credit. Others can successfully manage dozens of credit card accounts.
The right number of credit cards for you may be different than the number that works for the next person. As a rule, only open as many credit cards as you want to manage – with the aim of paying out your entire bill balance on each account every 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 creditworthiness factors that are more likely to affect you are:
Our advice is to consistently pay your credit cards on time and therefore keep your balance-to-limit rates (or loan utilization ratio) low. If you follow these rules, you should be off to a good start in the Schufa department – unless there are other issues with your credit report. You may also consider paying off your credit card balances early to potentially improve your credit score in some situations.
Finally, pay attention to how often you apply for new credit, such as credit cards and loans. An excessive number of tough credit inquiries can hurt your credit score — but if you’re experiencing an inquiry-related credit decline, it may not be as severe. According to FICO, one additional hard credit request removes less than five points from most people’s FICO score.
Does Canceling a Credit Card Damage Your Credit Score?
Some people mistakenly assume that canceling a credit card will improve their credit score. In fact, closing a credit card can even negatively impact your credit score.
When you close a credit card, there’s a chance you’ll trigger an increase in your overall credit utilization ratio. If the ratio on your credit report goes up, your credit score can slide down.
There are ways to protect your credit score when canceling a credit card. So if there’s a compelling reason you need to close a credit card account, check out this TPG guide for tips on navigating the process.
Learning the basic financial services and credit card concepts above can help you in many ways. When you understand more about money and finance, 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.