The type of credit card you're most likely familiar with is an unsecured card. With an unsecured card, you don't need to put down a deposit or offer any collateral to get the card. You're expected to pay the charges as agreed, and the lender doesn't have any tangible property to hold against you. Unsecured credit cards can give you a good amount of freedom, but they have huge drawbacks, especially if your spending spirals out of control.
Spending Imaginary Money
When you get an unsecured credit card, you usually get a credit limit. That limit can be thousands of dollars or it can be just a few hundred. The thing to remember is that the money isn't actually there. When you use your card to purchase items, you're spending money you might not actually have. If you over-spend, you can wind up deep in debt, especially if you don't have the funds to pay the entire balance off at the end of the month.
Interest Adds Up
Compared to interest rates on practically every other financial product, the interest rate on credit cards is staggeringly high. Your mortgage interest rate might be 5 percent or less and the interest your savings account earns might be less than 1 percent. But the interest rate charged on your credit card can be 10 or 20 percent, or even higher, depending on your credit history. If you are in the market for a new credit card, look for one that offers you the best, fixed interest rate and always pay on time. Under the Credit CARD Act passed in 2009, the card company needs to give you a reason for raising your interest rate and must re-examine that rate every six months, according to the Federal Reserve.
Dings Your Credit
Whether you pay on time or not has a big impact on your FICO credit score. Your credit score plays a big role in getting other loans, such as a mortgage. In some cases, it can affect your ability to get a job, because many employers take a peek at your credit before hiring. Your payment history makes up 35 percent of your score, which means that if you have an unsecured card and you miss payments or pay a few days late, you can be damaging your credit. Another way to ding your credit score via credit card is to run up a balance on the card. If you have large amounts of debt, your score is negatively affected.
That unsecured card can come along with a number of fees. Although the CARD Act does put some limits on the fees a card company can charge, you can still face a fee if you don't pay on time, usually up to $35. If you choose to opt in to an over-the-limit program, your card can slap on a fee if you go over your credit limit. Some cards also charge an annual fee, which is the amount you need to pay for the benefit of using that particular credit card.
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- MyFICO: How to Repair Credit and Improve My Score
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- Federal Reserve: Credit Card Fees
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