When people talk (or write) about credit and credit cards, we often hear different terms being tossed around as though we’re supposed to understand what they mean. Some are easy to comprehend while others, well, they’re not so easy. And there are others we might think we understand but, when it comes down to it, we’re actually mistaken about their true meaning. So do you know these common credit card terms?
What follows are 5 credit card terms that will probably sound familiar. However, you might be surprised that they mean something totally different than what you originally may have thought.
1. APR and APY
There’s only a one letter difference between these two abbreviations, but their definitions couldn’t be further apart.
APR (Annual Percentage Rate) is money you pay. APR is the annual percentage rate a lender charges when you borrow money. APR is typically used for credit cards, mortgages and loans.
APY (Annual Percentage Yield) is money you make. APY is the rate of return on an interest rate and includes compound interest – the interest you earn on top of the principal and simple interest. It’s more commonly used for interest-bearing accounts like savings bank accounts and investments.
When making an investment (or opening a savings account) or applying for a credit card, take careful note of APR and APY. It could make thousands of dollars of difference in your income and your interest payments.
2. Annual Fee
Many credit cards charge an annual fee for the “privilege” of using their card. Often using the term “Membership Fee” or “Participation Fee”, the lender can charge anywhere from $10 to $350 or more. This fee is often related to the type of “rewards” you can get by using the card and getting “points”. You can then redeem those points to enjoy discounts on everything from travel and retail shopping to restaurants and gift cards. Carefully consider risk vs. reward before deciding to pay an annual fee. Will your rewards outweigh your fee? If not, consider finding a card with no annual fee at all.
3. Minimum Payment
Credit cards, like most loans, require a minimum amount to be paid each month in order to keep that account from going into default. With credit cards, the minimum payments typically equal 2% of the outstanding balance. Always pay this minimum amount in order to keep the payment history factor of your FICO® Score in good standing. If possible, pay more than the minimum payment each month so you can reduce the debt faster.
4. Finance Charges
These are two words no one likes to hear. We might not know exactly what they are, but we know they’re not a good thing. Most credit cards give you a certain amount of time to pay off your balance in full before charging a penalty (this timeframe is known as a “grace period”). The penalty, typically in the form of a finance charge, is an interest fee charged on the money you’ve borrowed.
A finance charge is usually imposed when
- A transaction is made without a 0% interest promotion in effect
- There’s a balance due at the beginning of a billing cycle
- The transaction isn’t offered a grace period (i.e. cash advance)
It pretty much goes without saying that the best way to not pay a finance charge is to pay your entire balance down each month.
5. Credit Limit
This term pretty much means exactly what it sounds like: it’s the maximum outstanding balance you can have on your credit card at any point in time without getting charged a penalty (typically a higher rate than your current rate). You can learn what your credit limit is by checking your credit card agreement, your billing statement or simply by calling your credit card’s customer service line.
When you near your credit limit or exceed it, your credit score could be negatively impacted. This is due to credit utilization – the FICO® Score factor that measures the amount of your total credit being used and accounts for 30% of your credit score. The higher your credit card balance in relation to your credit limit, the higher your credit utilization and impact on your credit score. That’s why it’s so important to know your credit limit before making too many purchases!
When myFICO members aren’t sure about a term, topic or anything credit-related, they turn to the myFICO forum. It’s a great place to listen, learn and get advice from credit-conscious people just like you! If you’re looking for a credit card, check out the myFICO Saving Center.