How to Use a Credit Card: Best Practices Explained

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Whether you've been using credit cards for years or you're applying for your first one, they can be confusing. Depending on how you use them, credit cards can either be incredibly dangerous or immensely helpful. This guide will walk you through what you need to know about using a credit card, building credit and earning rewards.

How to use a credit card: The 4 principles to master

You should always handle credit cards with extreme care. Unlike debit cards, you're making purchases on credit — meaning you're 100% liable for paying back everything you charge to your credit card. If you aren't careful, you can end up in a lot of debt.

There are four main principles to becoming a credit card master. If you take away anything from this guide, you should always follow the first rule — pay your bill on time and in full every single month. This strategy alone will help your personal finances tremendously.

If you'd like to learn other ways to maximize your credit card use, read on for the best practices for managing your credit card.

Rule #1: Always pay your bill on time (and in full)

The most important principle for using credit cards is to always pay your bill on time and in full. Following this simple rule can help you avoid interest charges, late fees and poor credit scores. By paying your bill in full, you'll avoid interest and build toward a high credit score.

The consequences of missing a payment By consistently missing payments, you could end up paying hundreds of dollars in late fees. The negative consequences spiral — once your credit score takes a hit, you could face thousands in interest when applying for future mortgages or loans. If you're unable to pay your bill on time, it may be time to cut up your card.

You're usually given multiple options to pay your credit card statement each month. While it may be tempting to pay just the minimum payment — which could be as low as $25 — you'll start to accrue interest, leading to years of debt. The best practice is to pay off your credit card bill as soon as you make a purchase. This way, you can get into the habit of paying your bill long before its due date.

Each month, your issuer will provide your credit card statement with two dates: the closing date and payment date:

The closing date is the last day you can make a charge for a monthly statement. After the closing date, any new transaction will go onto next month's statement.

is the last day you can make a charge for a monthly statement. After the closing date, any new transaction will go onto next month's statement. The payment date tells you when the payment for a particular statement is due.

In the example above, this user has a closing date of Jan. 16 and a payment date of Feb. 13. This monthly statement ran from Dec. 17 to Jan. 16, with a payment due on Feb. 13. In this case, you have a 28-day grace period after your statement date before you're required to make a payment. You won't be charged any interest during this grace period as long as you pay in full by the due date.

All credit cards are different and will have varying billing cycles, payment dates and grace periods. Review the information for your credit card to understand how it works for your situation. If you're having trouble remembering to pay your bill, most issuers will allow you to set up automatic payments or schedule reminders each month.

Rule #2: Keep your balances low by only charging what you can afford

In addition to making on-time payments, it's essential to keep your balance low relative to your available credit limit. There are two main benefits to maintaining a small balance:

Low balances help increase your credit score.

You're more likely to pay off your balance in full and on time.

Many factors determine your credit score, but a significant portion (30%) comes from credit utilization. In other words, this is the ratio of what you owe to your total credit limit. For instance, if you have a credit limit of $1,000 and charge $500 to your card, your credit utilization would be 50%.

While there's no clear definition of your credit utilization, experts believe that you should keep it under 30%. Anything higher than that can decrease your credit score. To achieve a low credit utilization ratio, you should typically charge less than you can afford. By keeping a low balance, you minimize the chance that you'll spend more than you can pay off at the end of the month.

Finally, don't view your credit card as an extension of your budget. You should never charge more than what you can currently cover in your bank account. It's tempting to spend ahead based on what you know you'll get paid, but it's a bad practice. If you lose your job or run into an emergency, you won't be able to cover those charges. People don't intend on having credit card debt — it builds slowly and becomes a vicious cycle that becomes hard to break.

Rule #3: Understand how interest is calculated

Contrary to popular belief, interest isn't calculated based on the remaining balance after making a minimum payment. In reality, issuers calculate interest based on your average daily balance, calculated by taking your card's APR (Annual Percentage Rate) and dividing this number by 365.

For example, assume you have a statement balance of $1,000 and make a payment of $800 on the due date. You'll be charged interest on the remaining balance of $200 and lose your grace period. In the new billing cycle, any transactions will begin accruing interest immediately. The grace period where no interest is charged only applies if you pay your balance in full by the payment date.

Rule #4: Monitor your monthly statement

Monitoring your statement helps you check for fraud, stay on a budget and maintain a low balance. Even if you've set up an automatic payment, it's still wise to log in and check your statement every month to ensure there are no suspicious transactions.

Thankfully, most issuers have sophisticated technology that checks for fraudulent charges, but they may not catch them all. At least once a month, you should check your statement and verify there aren't any purchases you don't recognize.

In addition to checking for fraudulent activity, monitoring your statement will help you stay on budget. There's no way to know if you're maintaining a low balance, keeping your spending in check, or blowing the budget unless you're regularly checking in.

How to use a credit card to build credit

As the name suggests, credit cards are one of the foremost tools for building a credit score and can make a great foundation for your credit history. The best way to build your score using credit cards is to follow the recommendations listed above: Pay on time and in full, and keep a low balance. Below, you’ll learn how credit scores are calculated and exactly how credit cards affect them.

Know how your credit score is calculated

The FICO Score is the most commonly used credit score that most lenders refer to and is made up of five key components:

Payment history is determined by how often you pay on time and how reliable you are as a borrower.

is determined by how often you pay on time and how reliable you are as a borrower. Credit utilization is the ratio between how much you borrow (balance) to how much is available to you (credit limit).

is the ratio between how much you borrow (balance) to how much is available to you (credit limit). Length of credit history is how long you've used credit — the longer, the better.

is how long you've used credit — the longer, the better. New credit is how often you apply for credit products or loans, and what percentage of your credit comes from recently opened accounts.

is how often you apply for credit products or loans, and what percentage of your credit comes from recently opened accounts. Credit mix is how many different types of credit you use.

FICO Scores range from 300 to 850, and the average score is 701. It takes time and patience to build your credit score. Since the length of credit history determines 15% of your score, it's a good idea to start early and learn how to manage your credit properly.

Other strategies to help you build your credit score

Payment history and credit utilization make up 65% of your score. Because these two factors alone comprise the majority of your score calculation, you should maintain a low balance and never miss a payment to beef up your score. If you're already following these principles, here are four more strategies to help you build your credit score:

Never cancel your first credit card . Unless it has an annual fee, you want to keep your oldest line of credit as long as possible, as this will help your average account age.

. Unless it has an annual fee, you want to keep your oldest line of credit as long as possible, as this will help your average account age. Ask for a credit-limit increase, but don't increase your spending . Call your credit card company for a credit-limit increase if you want to reduce your credit utilization ratio. This tactic will help your utilization score by decreasing your ratio.

. Call your credit card company for a credit-limit increase if you want to reduce your credit utilization ratio. This tactic will help your utilization score by decreasing your ratio. Open a new credit card and then set a recurring bill and automatic payment to that card . Setting up this small recurring payment (such as a streaming subscription) will help both your overall utilization and your payment history.

. Setting up this small recurring payment (such as a streaming subscription) will help both your overall utilization and your payment history. Pay off all your credit cards a few days before each statement closes if you're applying for a loan soon. Paying off your cards early will decrease your overall utilization and boost your credit score for a few days.

How to use a credit card to earn cash back and rewards

Earning rewards from a credit card is the fun part. But first, you should consider what your top spending categories are, then pick a card that will provide the best returns for you. Everyone's spending habits are different — some people may spend a lot on travel, while others only spend on groceries or takeout.

Analyze your spending habits to maximize your rewards

Take a look at the past few months of your spending and categorize it as best you can. Ask yourself the following questions: Do you spend a lot on gas and groceries? How often do you travel? Can you put work-related purchases on a credit card and then get reimbursed by your company?

Once you figure out which categories you're spending the most in, start researching different credit card options that fit your needs. After analyzing your spending, you may find that you want to use two credit cards to maximize rewards. However, while juggling cards can help you earn more rewards, don't get so distracted you end up spending more than you usually would.

Understand cash back vs. points vs. miles

Next, you should consider which types of rewards you're looking for. There are three main types of rewards currency: cash back, points and miles. It may make sense to earn points and miles through travel rewards cards if you like to travel. If you prefer to earn cash rewards, look at cashback cards instead.

Credit card rewards can be confusing, and most credit cards have restrictions on how you can redeem the rewards. For example, some cards require a minimum redemption threshold, or you may have to wait multiple billing cycles to receive your rewards. Consider how much time and effort you want to put in versus getting a simple card with straightforward options.

Below, we've hand-picked our favorite beginner rewards credit cards that are easy to use and offer excellent returns:

Card Best for... Annual fee Rewards rate Chase Sapphire Preferred® Card Travel rewards $95 5x on travel purchased through Chase Ultimate Rewards®, 3x on dining and 2x on all other travel purchases Citi® Double Cash Card – 18 month BT offer Cashback $0 Earn 2% on every purchase with unlimited 1% cash back when you buy, plus an additional 1% as you pay for those purchases. Chase Freedom Flex℠ Card Rotating categories $0 5% cash back on up to $1,500 in combined purchases in bonus categories each quarter you activate. Enjoy new 5% categories each quarter! Plus, earn 5% cash back on travel purchased through Chase Ultimate Rewards®, 3% on dining and drugstores, and 1% on all other purchases.

ValuePenguin's verdict

A credit card can make or break your financial future. If used correctly, you'll enjoy a plethora of benefits, from a great credit score to valuable credit card rewards. However, if you fail to manage your credit card responsibly, you may find yourself spiraling out of control and into debt. Knowing the basic principles of using a credit card can avoid the latter outcome entirely and secure a promising outlook for your personal finances.

Financing: What It Means and Why It Matters

What Is Financing?

Financing is the process of providing funds for business activities, making purchases, or investing. Financial institutions, such as banks, are in the business of providing capital to businesses, consumers, and investors to help them achieve their goals. The use of financing is vital in any economic system, as it allows companies to purchase products out of their immediate reach.

Put differently, financing is a way to leverage the time value of money (TVM) to put future expected money flows to use for projects started today. Financing also takes advantage of the fact that some individuals in an economy will have a surplus of money that they wish to put to work to generate returns, while others demand money to undertake investment (also with the hope of generating returns), creating a market for money.

Key Takeaways Financing is the process of funding business activities, making purchases, or investments.

There are two types of financing: equity financing and debt financing.

The main advantage of equity financing is that there is no obligation to repay the money acquired through it.

Equity financing places no additional financial burden on the company, though the downside is quite large.

Debt financing tends to be cheaper and comes with tax breaks. However, large debt burdens can lead to default and credit risk.

The weighted average cost of capital (WACC) gives a clear picture of a firm's total cost of financing.

Understanding Financing

There are two main types of financing available for companies: debt financing and equity financing. Debt is a loan that must be paid back often with interest, but it is typically cheaper than raising capital because of tax deduction considerations. Equity does not need to be paid back, but it relinquishes ownership stakes to the shareholder. Both debt and equity have their advantages and disadvantages.

Most companies use a combination of both to finance operations.

Types of Financing

Equity Financing

"Equity" is another word for ownership in a company. For example, the owner of a grocery store chain needs to grow operations. Instead of debt, the owner would like to sell a 10% stake in the company for $100,000, valuing the firm at $1 million. Companies like to sell equity because the investor bears all the risk; if the business fails, the investor gets nothing.

At the same time, giving up equity is giving up some control. Equity investors want to have a say in how the company is operated, especially in difficult times, and are often entitled to votes based on the number of shares held. So, in exchange for ownership, an investor gives their money to a company and receives some claim on future earnings.

Some investors are happy with growth in the form of share price appreciation; they want the share price to go up. Other investors are looking for principal protection and income in the form of regular dividends.

Advantages of Equity Financing

Funding your business through investors has several advantages, including the following:

The biggest advantage is that you do not have to pay back the money. If your business enters bankruptcy, your investor or investors are not creditors. They are part-owners in your company, and because of that, their money is lost along with your company.

You do not have to make monthly payments, so there is often more cash on hand for operating expenses.

Investors understand that it takes time to build a business. You will get the money you need without the pressure of having to see your product or business thriving within a short amount of time.

Disadvantages of Equity Financing

Similarly, there are a number of disadvantages that come with equity financing, including the following:

How do you feel about having a new partner? When you raise equity financing, it involves giving up ownership of a portion of your company. The riskier the investment, the more of a stake the investor will want. You might have to give up 50% or more of your company, and unless you later construct a deal to buy the investor's stake, that partner will take 50% of your profits indefinitely.

You will also have to consult with your investors before making decisions. Your company is no longer solely yours, and if the investor has more than 50% of your company, you have a boss to whom you have to answer.

Debt Financing

Most people are familiar with debt as a form of financing because they have car loans or mortgages. Debt is also a common form of financing for new businesses. Debt financing must be repaid, and lenders want to be paid a rate of interest in exchange for the use of their money.

Some lenders require collateral. For example, assume the owner of the grocery store also decides that they need a new truck and must take out a loan for $40,000. The truck can serve as collateral against the loan, and the grocery store owner agrees to pay 8% interest to the lender until the loan is paid off in five years.

Debt is easier to obtain for small amounts of cash needed for specific assets, especially if the asset can be used as collateral. While debt must be paid back even in difficult times, the company retains ownership and control over business operations.

Advantages of Debt Financing

There are several advantages to financing your business through debt:

The lending institution has no control over how you run your company, and it has no ownership.

Once you pay back the loan, your relationship with the lender ends. That is especially important as your business becomes more valuable.

The interest you pay on debt financing is tax deductible as a business expense.

The monthly payment, as well as the breakdown of the payments, is a known expense that can be accurately included in your forecasting models.

Disadvantages of Debt Financing

Debt financing for your business does come with some downsides:

Adding a debt payment to your monthly expenses assumes that you will always have the capital inflow to meet all business expenses, including the debt payment. For small or early-stage companies, that is often far from certain.

Small business lending can be slowed substantially during recessions. In tougher times for the economy, it's more difficult to receive debt financing unless you are overwhelmingly qualified.

Special Considerations

The weighted average cost of capital (WACC) is the average of the costs of all types of financing, each of which is weighted by its proportionate use in a given situation. By taking a weighted average in this way, one can determine how much interest a company owes for each dollar it finances. Firms will decide the appropriate mix of debt and equity financing by optimizing the WACC of each type of capital while taking into account the risk of default or bankruptcy on one side and the amount of ownership owners are willing to give up on the other.

Because interest on the debt is typically tax deductible, and because the interest rates associated with debt is typically cheaper than the rate of return expected for equity, debt is usually preferred. However, as more debt is accumulated, the credit risk associated with that debt also increases and so equity must be added to the mix. Investors also often demand equity stakes in order to capture future profitability and growth that debt instruments do not provide.

WACC is computed by the formula:

WACC = ( E V × R e ) + ( D V × R d × ( 1 − T c ) ) where: E = Market value of the firm’s equity D = Market value of the firm’s debt V = E + D R e = Cost of equity R d = Cost of debt T c = Corporate tax rate begin{aligned}&text{WACC} = left ( frac{ E }{ V} times Re right ) + left ( frac{ D }{ V} times Rd times ( 1 - Tc ) right ) \&textbf{where:} \&E = text{Market value of the firm's equity} \&D = text{Market value of the firm's debt} \&V = E + D \&Re = text{Cost of equity} \&Rd = text{Cost of debt} \&Tc = text{Corporate tax rate} \end{aligned} ​WACC=(VE​×Re)+(VD​×Rd×(1−Tc))where:E=Market value of the firm’s equityD=Market value of the firm’s debtV=E+DRe=Cost of equityRd=Cost of debtTc=Corporate tax rate​

Example of Financing

Provided a company is expected to perform well, you can usually obtain debt financing at a lower effective cost. For example, if you run a small business and need $40,000 of financing, you can either take out a $40,000 bank loan at a 10% interest rate, or you can sell a 25% stake in your business to your neighbor for $40,000.

Suppose your business earns a $20,000 profit during the next year. If you took the bank loan, your interest expense (cost of debt financing) would be $4,000, leaving you with $16,000 in profit.

Conversely, had you used equity financing, you would have zero debt (and as a result, no interest expense), but would keep only 75% of your profit (the other 25% being owned by your neighbor). Therefore, your personal profit would only be $15,000, or (75% x $20,000).

Frequently Asked Questions

Is Equity Financing Riskier than Debt Financing? Equity financing comes with a risk premium because if a company goes bankrupt, creditors are repaid in full before equity shareholders receive anything.

Why Would a Company Want Equity Financing? Raising capital through selling equity shares means that the company hands over some of its ownership to those investors. Equity financing is also typically more expensive than debt. However, with equity there is no debt that needs to be repaid and the firm does not need to allocate cash to making regular interest payments. This can give new companies extra freedom to operate and expand.

Main types of finance

Need finance for your business? Learn about the types of finance, approaching lenders and investors and more.

What is business finance? Your new business idea is ready to go. Now you need to find the right small business funding. But where do you start?

How much business funding do you need? Knowing how much money you need will help you choose the right type of finance. These tips will help you find a number.

Debt versus equity finance Most forms of funding fall into one of two camps. Let’s look at the main pros and cons of debt versus equity.

Main types of finance It takes money to make money. So what sort of finance options are there? Here are the types that fund most businesses.

How to get a business loan Getting a business loan is still one of the most common ways to finance a business. So let’s look at how to get one.

Peer-to-peer lending Peer-to-peer lending is an alternative method of getting a business loan. How does it work?

Friends and family loans Friends and family loans may be available when other types of finance aren’t, but they do require some precautions.

Invoice financing Ever thought your cash flow would be better if everyone just paid what they owed you? Well, you may not have to wait.

How to find investors How do you find investors for equity financing? Let’s look at what types there are and where to locate them.

Angel investors versus venture capitalists Angel investors and venture capitalists are alternative finance sources. What can they offer your business?

How crowdfunding works Crowdfunding can get you money to build a business, and the attention to build a customer base.

Small business grants Grants are a great funding option for some businesses. They can be a lot of work to get, but the reward is free money.

Pitching for business funding Seeking business funding is a major step but you needn’t be daunted. Here’s how to pitch your business.