Credit Cards 101

April 3, 2023

Planning & Saving

Chaim Newhouse was embarrassed to admit it, but he didn’t understand how credit cards worked. He knew that you could pay for things by using credit cards, but then what? Now his chavrusa was talking about getting a free vacation just by applying for a new card. It sounded too good to be true, but his chavrusa said many people were doing it. Was this all some kind of gemach or government program that gave away money and vacations?

How do credit cards work? Who’s giving out the free vacations and why?

Credit Card Basics

Credit cards are a powerful financial tool that can provide convenience, security, and, yes, free rewards. Moreover, they are essential to building credit, a necessary ingredient for procuring loans, including mortgages. However, those using cards need to understand how they work. Some people don’t know what they are getting into before they begin swiping. And many people who get the basics still end up sliding into mounds of high-interest credit card debt as they pursue “free” points and miles. In this article, we’ll cover how credit cards work, the freebie angle, and some basic tips to use them responsibly.

Loan Devices

Credit cards allow you to borrow money from a financial institution to make purchases. When you use a credit card, you essentially take out a loan which you will have to pay back, usually with interest. Credit cards have a credit limit, which is the maximum amount you can borrow on the card. The credit limit is determined by the credit card issuer based on your creditworthiness, which lenders estimate and monitor based on your income and records of your credit history.

The Loan Terms

When you make a purchase with a credit card, the credit card issuer, acting as the “bank,” pays the merchant on your behalf. You are then responsible for paying back the financial institution that laid out the funds. If you pay off your balance in full each month during the allotted grace period, you will not be charged any interest. However, if you carry a balance of any size beyond that grace period, you will be charged a hefty rate on the unpaid balance, and the new charges won’t have a grace period either.

High Loan Rates

According to Federal Reserve data, 75% of American households had at least one card and Americans collectively had $1 trillion in outstanding credit card debt as of the end of 2022. The banks lending all that money are definitely not in it for the chessed. Eighty percent! of borrowers do not pay off their balance during the grace period and are charged very high interest—an average of 19% according to government data! In addition to these massive interest charges, credit card companies make money from annual fees, late payment fees, and balance transfer fees.

Credit Card Bites

Far from being gemachs, credit card lenders make big bucks from their borrowers. They “graciously” allow users to pay just small minimum monthly payments in the hope that outstanding balances and interest owed mushroom into a steady stream of profits for them. The Torah calls the charging of any loan interest neshech because it tends to take a painful, damaging bite out of the borrower. All the more so for those sucked into rising debt loads accruing at 19% or more.

Freebies or Bait?

Credit cards can be convenient. In addition to not having to carry cash around, as long as card balances are paid monthly in full before the grace period, borrowers are indeed getting a free short-term loan. To make things even more enticing, many credit cards have rewards programs, offering cash back, hotel points, or airline miles for opening cards and making purchases. So, those paying their balances in full monthly can get a free loan plus rewards worth hundreds or even many thousands of dollars from their credit cards.

A Super-Slippery Slope

However, most credit card users do carry balances and pay heavy interest. Often, people start using cards for convenience and freebies, planning to pay their balances in full monthly. Then one month, something happens, and the next thing they know, interest starts accruing and the trap has been sprung. Many get baited by freebies into an endless cycle of credit card debt. Eventually, as balances grow, they make minimum payments until they max out their credit. Then they can’t use their cards…and they just pay and pay and pay.

Use Responsibly

So, how can one use credit cards responsibly? Here are some tips for beginner users to consider:

Understand the terms: Before applying for a credit card, look past the miles and make sure you understand the grace period, payment requirements, credit limit, interest rate, and potential fees associated with the card. Understanding the details can help you avoid unnecessary fees and keep your credit card debt under control.
Stick to your budget: It’s easy to overspend when using a credit card, as the money you spend doesn’t feel like real cash. Use your credit card only for purchases you know you can pay off in full each month, and avoid using it for impulse purchases or nonessential expenses.
Pay your balance in full each month: One of the most important things you can do to use a credit card responsibly is pay your balance in full each month. When you carry a balance, you will be charged interest on the unpaid balance and new charges, which can quickly add up and make it difficult to pay off the debt.
Monitor your credit card statements: It’s important to regularly monitor your credit card statements to ensure that there are no unauthorized charges and to keep track of your spending. By checking your statements regularly, you can catch any errors or fraudulent activity early and take action to address it.
Be careful or even abstain: Many—even smart and high-earning people—do get trapped in credit card debt, so no one should take it lightly. It is often better to forgo the temptation of credit card freebies altogether.