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What is pre-approval for credit cards and loans?

Pre-approval for a credit card or loan puts borrowers one step closer to securing new credit they can use to make future purchases. It’s important to understand that not all pre-approvals are the same, and none guarantee credit will be extended. Learn what pre-approval means, how it works, common steps needed to get pre-approval, and ways to make pre-approval more likely.

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What pre-approval means for credit cards and loans

Pre-approval means a lender such as a credit card company or a bank has done some initial homework on a borrower’s financial history. After this review, they’ve concluded the borrower is likely a good candidate for new credit. Lenders reach this decision in a few ways. They have studied the borrower’s credit report, which indicates reliability, timely payments and good credit habits. The borrower likely has a good to strong credit score.

Having pre-approval in writing from a lender benefits borrowers in a few ways. It can reduce the hassle, paperwork, and time needed to get a new credit card or loan. Pre-approval does this because it signals to any people involved in a financial transaction that the borrower is a good fit for a loan. For example, if a bank pre-approves a car loan up to a certain dollar amount, it gives the car dealer greater confidence to make the sale. They can have confidence they’ll be paid back on time. In the case of a mortgage, pre-approval reassures the seller of a house that the buyer has the financial capacity to make such a major purchase.

How pre-approval works

The process of pre-approval involves a thorough review of the borrower’s financials. Often, lenders have trained financial professionals who review a borrower’s credit history, income statements, and tax returns. Not every pre-approval is this thorough. Some lenders require less information than others. Remember, pre-approval isn’t a guarantee that credit will be given. Additional documentation and signatures will be required before any offer of credit becomes official.

How pre-approval works for different loan types

Although the basics of pre-approval remain the same, borrowers might experience some nuances along the way. Here are a few examples.

With credit cards

In some cases, borrowers might get a mailer, a push notification to their phone, or an email stating they are pre-approved for a credit card. The borrower doesn’t have to contact the credit card vendor. The credit card company comes to them. In other cases, borrowers might research which credit cards seem to be a good fit and apply for pre-approval. They will input basic details about their credit, financial profile, and income. The process is generally straightforward.

With car loans

Many car buyers first visit their bank to seek pre-approval for an auto loan. Assuming the borrower works with the bank already, the financial institution will have many of the required documents on file. These allow the bank to assess the borrower’s level of risk. It helps them decide the right credit amount to extend. The bank generally provides papers the car buyer can take to a dealer. This makes the purchase go faster and gives the auto dealership the security it needs to complete the sale.

With mortgages

If borrowers are looking for a home, they will often get pre-approval quotes from several lenders. This could include a quote from a personal bank and other lenders to see which will offer the best interest rates and payment terms. To provide formal pre-approval, banks will need a combination of signed tax returns, W-2 forms about the borrower’s employment, and bank and investment account documents.

How to make pre-approval more likely

Several activities can help borrowers increase their chances of successful pre-approval. Think of these as good credit habits that can be put to use at any time, even if the borrower won’t seek pre-approval for months.

Studying credit reports and scores

Get familiar with the free annual credit report available to every borrower. Free access is easy to obtain by downloading the Credit Sesame app. In addition to information about a borrower’s debt types, payment history, and loan terms, the app provides an updated credit score. This information can become a baseline for borrowers to improve against. For example, borrowers could aim to add 20 points to their credit score, get current on loan payments, or add a new type of debt for a better credit mix. These types of strategies could result in stronger credit, a better credit score, and a greater likelihood of pre-approval for future credit cards or loans.

Collecting financial paperwork

Borrowers who want pre-approval need evidence they can pay down debt on time, every time. Gather at least the most recent two years of signed tax returns. Compile pay stubs and W-2 income statements. Assemble documents about any other debts or investments such as retirement accounts or education savings funds. This will provide prospective lenders with everything they need to decide whether to extend pre-approval.

Meeting with potential lenders

Automated pre-approval is common. This means a computer analyzes a borrower’s financial details and recommends whether to pre-approve them. Additionally, a phone call, videoconference or in-person meeting between a borrower and a prospective lender can be beneficial. It helps borrowers build relationships with lenders, allows them to ask questions, and gives them more information about the pre-approval process. This is especially true for auto loans and mortgages or for credit cards offered by a local bank in the borrower’s community.

Does pre-approval guarantee the borrower will get a loan?

Pre-approval never guarantees the borrower will get a loan. Instead, pre-approval gives the borrower greater confidence they can secure a loan at some level. Meanwhile, it gives the lender greater visibility into the borrower’s financial picture. It provides them with solid data that signals whether a borrower will pay back a debt. Pre-approval should be viewed as one step closer to a loan agreement, even though it’s not guaranteed.

How does pre-approval work for people with bad credit?

Low credit scores, bankruptcies, or other issues can hurt credit and limit pre-approval opportunities. It might take time for borrowers to build their credit to the point of getting approval. Take care to make timely payments on debt, use a mix of debt types, and maintain a solid income. A new job with higher income or several years of demonstrated ability to make payments on owed balances can produce stronger credit more likely to lead to pre-approval.

What's the difference between pre-approval and pre-qualification?

Pre-qualification is less rigorous and based on fewer data points. Pre-approval generally requires more paperwork and a deeper look at the borrower’s money management experience. Borrowers who are pre-qualified for a loan offer often need to take the next step of pre-approval. Later, they can take the final step of getting an exact loan amount and signing to get the funds.

In other cases, lenders use pre-approval and pre-qualification to mean the same thing. It’s a good idea to read the fine print on any advertising that claims borrowers are pre-qualified or pre-approved. Make sure to understand what this particular lender means and what exactly they’re offering. Investigate the loan’s interest rate, credit cap, and other features to ensure it’s a good fit.

Remember, both pre-approval and pre-qualification are one step of many. They don’t guarantee the borrower will get a loan. Be open to the possibilities and ask lots of questions in case there are strings attached.

Pre-qualification and pre-approval can help streamline decisions about opening new loans. They can point to offers that best fit a borrower’s financial track record. On the other hand, lenders look for ways to market pre-approval opportunities year-round. Borrowers should study their budgets and understand what’s in their best interest rather than pursuing the first pre-approval advertisement to hit their inbox. More opportunities for pre-approval are likely.

Does pre-qualification or pre-approval require a credit check?

Loan pre-qualification typically does not involve a hard credit check. Lenders often perform a soft credit inquiry during pre-qualification, which does not impact credit score. This inquiry provides a general overview of borrower creditworthiness.

Loan pre-approval usually requires a more detailed assessment of a borrower’s financial situation, which may involve a hard credit check. A hard inquiry can have a small, temporary impact on credit score. It’s important to check with the specific lender to understand their process and whether they will perform a soft or hard credit check during pre-qualification or pre-approval.

What strategies can boost income for pre-approval?

Sometimes, borrowers are unable to get pre-approval for a loan because their income is too low. There are several ways to increase income to boost eligibility.

If a borrower holds a steady job, they can look for opportunities for advancement in the business where they work. This could include taking on more responsibilities, working overtime, or applying for a leadership position with management duties.

Other borrowers prefer to supplement their income with side hustles. Popular options include driving for a rideshare service, providing shopping and delivery services for customers, or turning a hobby into products that can be sold online.

Lenders want to see evidence that borrowers can maintain a steady income over a period of months and years. They want to see income staying about the same or grow higher, rather than going sharply higher or lower in unpredictable ways. A steady paycheck suggests the borrower will be able to make timely loan payments.

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What are pre-approval watchouts?

Not every pre-approval offer is a good fit for every borrower. Just because a pre-approval offer looks attractive doesn’t mean it makes financial sense. Study the details before committing to sign any agreements. 

 

Ask questions such as:

  • Does the loan offer a fixed interest rate, or will it fluctuate with the market?
  • Will the borrower get an entry rate that eventually rises to a certain level after a period of months?
  • Can the loan be used for certain purchases but not others?
  • Will everyone accept the credit card or loan, or can it only be used with specific vendors?

Doing the research and knowing the answers to these questions helps borrowers make an informed financial decision. Understand pros and cons before getting locked into an agreement.

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In a nutshell

Pre-approval can sound confusing because so many organizations offer this to borrowers. The process is pretty straightforward with a clear purpose: to give the borrower and lender greater confidence in moving forward to a formal loan offer.

While pre-approval provides a significant step toward obtaining credit, it's crucial to remember that it doesn't guarantee a loan. Stay informed, ask questions, and make well-informed financial decisions to ensure that any pre-approval aligns with needs and goals.

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]]> How to read your credit card statement https://www.creditsesame.com/learn/credit-cards/how-to-read-your-credit-card-statement/ Wed, 14 Aug 2024 10:23:30 +0000 https://www.creditsesame.com/?post_type=learn-knowledge-hub&p=206416 How to read your credit card statement Understanding your credit card statement is crucial for financial management. It provides valuable insights into your spending, transactions, and billing accuracy. In this article, we will guide you through the process of reading and interpreting your credit card statement, empowering you to make informed financial decisions with confidence. […]

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How to read your credit card statement

Understanding your credit card statement is crucial for financial management. It provides valuable insights into your spending, transactions, and billing accuracy. In this article, we will guide you through the process of reading and interpreting your credit card statement, empowering you to make informed financial decisions with confidence.

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What is a credit card statement?

A credit card statement is a detailed record of your credit card account activity over a specific billing cycle. It summarizes your financial transactions, highlighting purchases, payments, fees, rewards, and more. This monthly statement the credit card issuer provides helps cardholders keep track of their spending, monitor their account balances and review any outstanding debts. Understanding how to read a credit card statement is useful for managing personal finances effectively.

A credit card statement is considered a legal document. It serves as an official record of your credit card account’s financial transactions and activities. The credit card statement is typically generated by the credit card issuer and provided to the cardholder every month.

As a legal document, the credit card statement includes crucial information such as the account balance, transaction history, interest charges, fees, and minimum payment due. It outlines the contractual agreement between the cardholder and the credit card issuer, including the terms and conditions governing the use of the credit card.

Keeping credit card statements as part of your financial records, reviewing them regularly for accuracy, and detecting any unauthorized charges or errors is a good idea. In case of disputes or discrepancies, the credit card statement can be used as evidence to support your case when dealing with the credit card issuer or in legal proceedings if necessary.

What information is on a credit card statement?

It helps to understand the information and data you typically find on your credit card statement.

Account summary

The account summary provides a snapshot of your credit card account key details. This includes:

  • Current outstanding balance
  • Total credit limit
  • Available credit (credit limit minus current balance)
  • Minimum payment due.
Transaction history

This is a comprehensive list of all transactions made with the credit card during the billing cycle. Typically, each transaction is listed with details such as the transaction date, the merchant’s name or description, the transaction amount, and whether it was a purchase, cash advance, or balance transfer.

Payments and credits

This section details any payments you made during the billing cycle, including the payment date and amount. It may also show any credits applied to your account, such as refunds or cash-back rewards.

Interest and fees

Interest and fees include any interest charges incurred on the carried-over balance (if you did not pay off the full balance) and itemized fees associated with the credit card, such as annual fees, late payment fees, or cash advance fees.

Credit limit and available credit

This part shows your credit card’s total credit limit (the maximum amount you can charge) and the remaining credit available for use (credit limit minus current balance).

Minimum payment warning

Credit card issuers must include a warning indicating how long it would take to repay the balance if you only make the minimum payment each month. This is to raise awareness of the potential cost of carrying a balance.

Rewards summary

If your credit card offers rewards, the rewards summary outlines your accumulated rewards points, miles, or cash-back earnings. It may show the total rewards earned during the billing cycle and the overall rewards balance.

Statement date

This is the last day of the billing cycle for which the credit card statement is generated.

Due date

The due date is the date by which you need to make the minimum payment or the full payment to avoid late fees and penalties.

Previous balance

The previous balance is the outstanding balance on your credit card at the end of the previous billing cycle.

New charges

The new charges section summarizes the charges and transactions made during the current billing cycle.

Interest rate

The interest rate, expressed as an annual percentage rate (APR), is the rate at which interest is charged on carried-over balances or cash advances.

Payment allocation

If you made a payment that exceeds the minimum due, this section may show how the payment was allocated to different balances, such as purchases, cash advances, or balance transfers.

Foreign transaction fees

If applicable, this section lists any fees incurred for transactions made in a foreign currency or with an international merchant.

Grace period

The grace period is the number of days you have to pay your bill without incurring interest charges. Usually, it starts from the statement date to the payment due date.

Promotional offers

If your credit card has special promotional offers, such as a 0% APR for a certain period, they may be listed separately with details of the offer terms.

Security and fraud alerts

This section typically provides instructions on what to do if you notice any suspicious or unauthorized activity on your credit card and the contact information for reporting such incidents.

Cardholder benefit

Some credit card statements include information about additional benefits or perks associated with the credit card, such as travel insurance, purchase protection, or extended warranties.

Contact information

The credit card statement usually includes customer service or credit card issuer contact details for inquiries or assistance.

Terms and conditions

Some credit card statements may include a summary of the card’s terms and conditions, referencing where you can access the full terms.

Do credit card statements vary depending on the card issuer?

While they generally contain similar information, each credit card issuer may present the statement differently and include additional features or details specific to their card offerings and policies. Some of the variations you might encounter between credit card statements from different issuers include:

  1. Layout and design. Credit card statements may have different layouts and designs, with font styles, colors, and overall formatting variations.
  2. Order of sections. The order in which the sections appear on the statement may differ between issuers.
  3. Additional information. Some issuers may include extra information or promotional offers on their statements, such as rewards program updates or special discounts.
  4. Online access. The online presentation of credit card statements can differ between issuers’ websites or mobile apps.
  5. Fees and charges. While all statements include details about fees and charges, the specific breakdown and terminology used may vary.
  6. Payment instructions. Instructions for making payments may differ slightly, such as the mailing address for payments or available payment methods.
  7. Customer service information. The contact details for customer service or inquiries might be presented differently.

Despite these variations, credit card statements from all reputable issuers must provide clear and transparent information about the cardholder’s account activity, transactions, balances, and other essential financial details. Regardless of the differences, it is wise to carefully review your monthly credit card statement to ensure accuracy, detect any unauthorized transactions, and stay on top of your financial situation. If you have any questions or concerns about your credit card statement, contact your credit card issuer’s customer service for assistance.

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What information is not included on your credit card statement?

A credit card statement is an official record of a particular credit card account’s financial activity during a billing cycle. While it offers insights into your credit card account’s health, it does not contain information about other credit card accounts, bank account balances, investments, loans, income, or personal identifiers like Social Security numbers. Credit card statements do not display your credit score or provide tax-related details. Reviewing credit card statements regularly is useful so that discrepancies or unauthorized charges may be identified and addressed immediately. For a comprehensive view of your financial situation, you must access statements from other financial institutions and maintain a thorough financial record system.

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In a nutshell

Understanding how to read your credit card statement is important for maintaining financial control and making informed decisions. The statement provides a comprehensive view of your credit card activity, including transactions, payments, fees, and rewards. Reviewing your credit card statements regularly helps you to stay on top of your financial health, avoid potential issues, and safeguard yourself against fraud. Understanding your credit card statement is key to staying financially responsible and in control of your financial journey..

Mastering the art of reading your credit card statement is not just about understanding numbers and transactions. It is about taking charge of your financial well-being. Regularly analyzing your statements lets you spot trends, adjust spending habits, and identify potential financial risks. Being vigilant and proactive with your credit card statements can pave the way for a more secure and prosperous financial future, equipped with the knowledge needed to make smart money choices.

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]]> How do credit cards work? https://www.creditsesame.com/learn/credit-cards/how-do-credit-cards-work/ Wed, 14 Aug 2024 10:12:26 +0000 https://www.creditsesame.com/?post_type=learn-knowledge-hub&p=206411 How do credit cards work? A credit card is a payment card that allows you to make purchases on credit. It works by borrowing money from the card issuer, up to a set credit limit. You are required to repay the borrowed amount, either in full or through monthly installments, with interest charges applied if […]

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How do credit cards work?

A credit card is a payment card that allows you to make purchases on credit. It works by borrowing money from the card issuer, up to a set credit limit. You are required to repay the borrowed amount, either in full or through monthly installments, with interest charges applied if not paid in full. Credit cards can be physical, typically a small rectangle of plastic or in digital format.

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How do credit cards work behind the scenes?

A credit card provides you with a “line of credit.” That means you’re given a credit limit and can run your “balance” (the amount you owe at any one time) up to that limit.

But it’s not like a personal loan or mortgage that you pay back in equal installments. Providing you make the minimum payments required, you can repay the whole or parts of your balance as you wish. You can then borrow again up to your limit. And you can keep repeating that for as long as you have your card. Credit and store cards are sometimes called “revolving credit accounts” because the credit revolves in that way.

Of course, the fact you can do something doesn’t necessarily mean you should. There are good reasons to keep your card balances low, which you’ll read about below.

Meanwhile, you pay interest only on the balance outstanding on each month’s invoice. If you pay off your balance in full every month, you do not pay any interest charges.

Credit cards vs. debit and other cards

Credit cards are different from debit cards. A debit card does not provide you with a separate line of credit. You use it to make payments directly out of your bank account, usually a checking account. Indeed, it can be helpful to think of a debit card as a more convenient form of a checkbook.

Charge cards are also different from credit cards. American Express was a pioneer of these. Unlike with a credit card, you must pay off your charge card balance every month.

Finally, prepaid cards have become more popular over the last decade or so. These provide no line of credit. You must load money onto your card before you spend it. And, when it’s gone, it’s gone, though you can add more money whenever you want.

Credit cards are the safest way to pay

Credit cards are considered the safest payment method available. The Seattle Times dubs them a “consumer protection superweapon.”

By law, credit cards can protect you against fraud and shoddy or misdescribed goods and services. You can get your money back even if you pay a deposit for an item and the retailer goes bust before it’s delivered.

Only credit cards come with these statutory protections, which are provided by the Fair Credit Billing Act. That means that you might not have to pay for such items when they appear on your monthly statement. Naturally, you must try to resolve issues with the merchant first. But, if that company is unresponsive or unreasonable, you can work with your bank on a resolution.

It is also true that most banks ultimately refund your money in many similar circumstances if you use a debit card, but there are important differences. To start with, there’s no law to force them to do so. So, you’re on flimsier ground from the beginning. And, secondly, the money has already left your bank account and you have to wait until your bank chooses to refund it.

This makes credit cards a great way to pay for goods and services in the short-term, when you pay off at the end of the month. However, they are not the best way to borrow over the longer term.

How do credit card rates work?

Credit card rates, also known as interest rates or Annual Percentage Rates (APRs), determine the cost of borrowing on a credit card. Here’s how credit card rates work:

  • Introductory rates. Some credit cards offer introductory rates, often called “teaser rates,” which are low or even 0% interest rates for an initial period. These rates are usually temporary and can apply to balance transfers, purchases, or both.
  • Standard APR. After the introductory period, a credit card’s standard APR comes into effect. This is the ongoing interest rate charged on any outstanding balances or new purchases. The standard APR can vary significantly depending on the credit card issuer, the cardholder’s creditworthiness, and prevailing market conditions.
  • Variable rates. Many credit card APRs are variable, meaning they can fluctuate based on changes in an underlying interest rate index, such as the prime rate. If the index rate goes up or down, the credit card’s APR adjusts accordingly.
  • Penalty APR. Credit cards may have a penalty APR that is higher than the standard APR. It typically applies when cardholders make late payments or violate the terms of the credit card agreement. Penalty APRs can be substantial and may remain in effect for an extended period.
  • Grace period. Most credit cards offer a grace period, which is the time between the purchase date and the due date when interest charges are not applied if the balance is paid in full. However, if the balance is not paid in full within the grace period, interest will be charged on the remaining amount.
  • Calculation of interest charges. Interest charges on credit cards are usually calculated based on the average daily balance method. This method takes into account the daily balances throughout the billing cycle and applies the daily periodic rate to determine the interest amount.

Maintaining a high credit card balance and paying only the minimum payment can lead to substantial interest charges over time. To minimize interest costs, pay off credit card balances in full each month or as soon as possible.

Credit card interest rates are higher than other loans

There are several factors that make credit card rates higher compared to personal loans and mortgages.

  • Unsecured debt. Credit cards are typically unsecured debt, meaning they are not backed by collateral. Unlike mortgages or car loans, where the lender can repossess the property in case of default, credit card issuers do not have a specific asset to recover their funds. The absence of collateral increases the risk for lenders, leading to higher interest rates to compensate for that risk.
  • Shorter loan terms. Credit card balances are usually revolving, meaning they can be carried over from month to month. This flexibility allows cardholders to make minimum payments and extend the repayment period. The shorter loan terms associated with credit cards compared to personal loans or mortgages mean that interest charges accumulate over a shorter time frame, resulting in higher rates to offset the lender’s potential loss.
  • Higher default rates. Credit cards have higher default rates compared to other types of loans. Due to their ease of use and availability, credit cards are often used for discretionary spending and emergencies. This greater risk of default is factored into the interest rates to compensate for potential losses incurred by the lender.
  • Higher administrative costs. Credit card issuers incur significant administrative costs, including customer service, fraud protection, credit monitoring, and rewards programs. These costs are built into the interest rates charged to cardholders.
  • Market competition. The credit card industry is highly competitive, with numerous card issuers offering various rewards and benefits. This competition puts pressure on lenders to offer attractive features, which can contribute to higher interest rates to cover the associated costs.

Personal loans and mortgages are typically secured debts, backed by collateral such as a home or a car. The presence of collateral reduces the risk for lenders, resulting in lower interest rates compared to unsecured credit cards. Additionally, personal loans and mortgages often have longer terms, allowing for spread-out repayments and reducing the impact of interest charges

What are rewards credit cards?

Rewards credit cards are a type of credit card that offers benefits or incentives to cardholders for their spending. These rewards can come in the form of cash back, points, miles, or other perks. Cardholders earn rewards based on their purchases, which can be redeemed for various rewards or discounts.

  1. Cash back. As statement credits or by check or electronic transfer to your bank account
  2. Points. Normally redeemed through your card issuer’s shopping portal, selected online retailers or gift cards
  3. Miles. Normally redeemed through your issuer’s travel portal when booking flights, hotel rooms and other travel-related costs
  4. Perks. Additional advantages or benefits provided, such as discounts, exclusive access, or enhanced customer services.
  5.  

Each credit card company gets to set its own rules for its rewards program. So, you need to make sure that the company and card you choose offer the program that best suits your needs and lifestyle.

More on credit card rewards perks

Some credit cards come with worthwhile perks. For example, an airline- or hotel-branded travel card might offer free access to one or more of the following:

  • Airport lounge access
  • Priority boarding
  • Checked bag
  • Discounted car rental
  • Hotel room upgrade
  • Complimentary breakfast and Wi-Fi
  • A higher tier in the company’s loyalty program
  • Concierge services

Some non-travel cards offer other perks, including travel insurance, travel upgrades, and protection from theft, damage or fraud on goods purchased using the card. Others may offer VIP experiences at concerts and sporting events.

As a rule, the cards with the most generous perks come with the highest annual fees. So, it’s up to you to shop around for a card with a fee-to-perks balance that suits your needs.

How do credit cards work with your credit score?

Your credit score can affect whether your credit card application is approved and the interest rate you pay. But did you realize how big an impact your cards are likely to have on your score? Paying your monthly card statement on time is hugely important, just as it is for your other bills. But there’s another influence on your score that only store and credit cards exert.

Credit utilization ratio or credit usage

Credit utilization ratio is the percentage of your credit limit that your balance represents. Suppose your card has a $5,000 limit and your statement balance is $3,000. Your credit utilization ratio is 60% because $3,000 is 60% of $5,000.

FICO, the company behind the most commonly used credit scoring technology, used to say you should keep your ratio below 30% to avoid harming your score. And VantageScore still says that.

However, FICO has recently changed its advice about the ideal ratio: “Generally, keeping it below 10% (and consistently paying bills on time) can help you build and maintain a good FICO® Score.”

That 10% sounds very low. But it might be wise to aim for it, especially if you’re applying for a mortgage, auto loan, credit card or other major borrowings anytime soon. This is because 30% of your credit score depends on your credit utilization ratio.

One solution may be to get several cards and spread the load across them all, keeping the ratio for each below 10%. Just leave plenty of time between each application because applying for too much credit over a short time may also harm your score.

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Your credit card goals

If you want to get the best from your credit cards, you should aim to:

  1. Pay off your balances every month. This way you never pay a cent in interest
  2. Keep each balance below 10% of that card’s credit limit. Your credit score should rise, all other things being equal
  3. Get the right rewards card. Find the rewards cards that deliver the things you value most
  4. Avoid cards with annual fees. Pay an annual fee only when it delivers perks and rewards that are worth more than that fee
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In a nutshell

Understanding how credit cards work is essential for responsible financial management. By using a credit card, you can make purchases, build credit history, and enjoy various perks and rewards. However, it's crucial to be mindful of interest rates and fees to avoid accumulating debt. Maintaining a good credit score and keeping a low credit utilization ratio are key to accessing favorable terms and unlocking better credit card offers in the future. By using credit cards wisely, you can leverage their benefits while staying in control of your finances.

Credit cards offer a convenient and flexible way to manage expenses and build creditworthiness. They provide a revolving line of credit, allowing you to make purchases and pay them off over time. However, it's important to use credit cards responsibly, paying attention to interest rates, fees, and rewards programs. By being aware of your spending, monitoring your credit, and making timely payments, you can maximize the benefits of credit cards while maintaining financial stability and achieving your long-term financial goals.

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What are business credit cards?

Business credit cards are useful cash management tools. Businesses of all sizes, from start-ups to large, established companies, can benefit from using them. The key to any tool is using it correctly.

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What is a business credit card?

A business credit card works much like a personal credit card but has some crucial differences.

A personal credit card is opened in the name of an individual consumer, while a business credit card is opened in the name of a company. This difference can have important implications for financial liability and credit history. However, a business credit card can still affect a business owner’s personal credit.

Business credit cards also have some distinct characteristics. From the type of rewards they offer to the data tools they provide, they often cater to businesses’ particular needs.

In principle, business credit cards operate like personal credit cards with a credit limit. Authorized users can use the card to pay for things up to the credit limit.

Payments made with the card will add to the balance owed on the card. The business must periodically pay down that balance to stay below the credit limit. Also, any balance outstanding at the end of a statement period will be charged interest.

Background of business credit cards

One reason why business and personal credit cards are so similar is that the providers offer both types.

The overlap between business and personal credit cards makes sense from a financing and marketing standpoint. A broader pool of customers helps keep credit flowing smoothly. Also, business contacts are often good personal credit customers, and vice versa.

Despite this overlap, some differences in business and personal credit cards have evolved based on the needs of each market.

Business vs. corporate credit cards

Interestingly, business credit cards and corporate credit cards are different.

Although business and corporate credit cards may be referred to as business cards, there is a distinction based on the size and history of the organizations using them.

Business credit cards are generally for smaller and newer ventures, such as start-up companies, sole proprietorships, or freelancers. Unless the entity already has a significant credit history, getting approved is likely to depend heavily on the business owner’s credit record. If the company does not pay its bills, liability for payment will be reverted to the owner. Any payment issues will reflect on the personal credit record of the business owner who applied for the card.

In contrast, corporate cards are available only to legally incorporated organizations. They typically must have revenues in the millions and their own credit history. Corporate cards allow more authorized users than business credit cards. Liability for payment rests on the corporate entity rather than the individual owners. The credit card company may require a minimum usage threshold to keep the account active.

Characteristics of business credit cards

Whether you choose a business credit card or a corporate card, they have some characteristics in common. Some may seem familiar to anyone with a credit card, while others differ from personal cards.

Company vs. personal credit history

If the business has a limited credit history, getting approved for a card will depend heavily on the owners’ creditworthiness. Their credit record and ability to pay will be key considerations. If applying for a business credit card requires the credit card company to pull the owner’s credit record, it might negatively affect that person’s credit.

If getting approved for a business credit card depends on your personal credit history, it would be wise to check your credit and clear up any problems before applying. This may qualify you for better terms and thus reduce your credit cost.

The more established a company is, the more a credit card issuer will consider the company’s credit history. This means looking at the company as if it were a person. Both the credit history of the company and its ability to make payments will factor into whether it gets approved for a card. This will also affect the interest rate charged.

Generally higher credit limits

Business credit cards generally have higher credit limits than personal cards. That is because companies generally have higher revenues and spending than individuals.

Still, when setting a credit limit, card issuers consider businesses almost as individuals. The company’s payment track record and ability to make payments will be considered.

Facilitating multiple users

The number of authorized users allowed on a single credit card account depends on the card issuer’s policies. As a general rule, though, business credit cards allow more authorized users than personal credit cards. This is especially true of corporate credit card accounts.

Spending and budgeting input

Many credit card issuers offer their business card customers detailed information on spending by user and category. This may be more detailed than what an individual would see on a credit card statement.

This detailed spending information can help track spending, budgeting by expenditure category, and identifying deductible expenses for tax purposes.

Business rewards

Like many personal credit cards, business cards often offer rewards based on the amount of spending on the card.

Business cards may offer reward programs geared toward business expenses. For example, they may offer bonus points for expenditures in certain business categories, such as office supplies.

Introductory interest rate

As with personal credit cards, it is important to consider the interest rate when signing up. The interest rate for a given account will depend on the customer’s creditworthiness and may differ considerably from the advertised rate.

Some business credit cards offer special low introductory rates – sometimes as low as 0%. These introductory rates will apply for a limited time, such as 12 months. That can be very useful for a start-up business, incurring upfront expenses before revenues kick in.

Annual fee

Business credit card fees are often higher than those for personal credit cards. This is because business credit cards offer features such as enhanced reporting and a higher number of authorized users. Also, as with personal credit cards, the cards with the most generous rewards programs will likely have higher fees.

Why having a business credit card is useful

Even if you are the sole business owner, it is a good idea to have a separate business card instead of a personal card. This is important from the start-up phase until the company becomes a larger established business.

Small businesses

For small businesses and start-ups, having a separate business credit card helps separate business spending from personal spending.

Keeping business spending separate may be necessary for tax purposes. It should also help you track spending and measure profitability and return on investment. The organization’s spending history can be a helpful guide to setting future budgets.

In addition, having a separate business credit card can be a useful step towards the company establishing its own credit history. This will give it more options for obtaining credit in the future.

Larger businesses

For larger businesses, enhanced reporting and the ability to accommodate more authorized users may be essential reasons to choose a business credit card.

Eventually, getting a corporate credit card can draw a clear legal distinction between the financial activities of the company and those of its owners. This is important for tax, liability, and credit reporting purposes.

Alternatives to business credit cards

In addition to credit cards, businesses have other forms of financing available. None of these are mutually exclusive—a business may find all of them useful for different situations.

Here are some common types of business financing other than credit cards:

  • Business loans. For borrowing that will take several months to pay off, a loan may be a better alternative than simply adding to the company credit card balance. Loans typically have lower interest rates, and their structured repayment schedule helps with budgeting.
  • Business line of credit. A line of credit operates like a credit card in that you can spend against it when needed and pay it down flexibly. However, by negotiating a line of credit with a lender, a business might obtain a higher credit limit and/or a lower interest rate than they could get with a credit card.
  • Vendor credit. A business that makes large, recurring purchases from a supplier could get credit from that supplier. This can allow the business to pay for those purchases over time rather than all at once. A supplier might offer a regular customer more favorable terms than other lenders.

Business credit cards offer more day-to-day flexibility than these other forms of credit. They are ideal for smaller expenses that will be quickly paid off. However, the above options may be more cost-effective for larger expenses that will be paid off over a longer time.

Business credit card problems to avoid

While business credit cards offer great convenience for short-term cash flow needs, some common problems should be avoided:

  • Carrying balances for extended periods. Credit cards are an efficient substitute for cash. However, there are more cost-effective ways to borrow money. Consider a loan or other source of credit instead for larger expenses that you will have to pay off over several months.
  • Mixing personal and business spending. Once you open a business credit card, you should avoid using it for personal spending. Doing so could muddy the distinction between personal and business spending, making it harder to budget and measure your business’s profitability. At worst, it could cause legal and tax problems.
  • Allowing too many authorized users. While letting multiple employees use company credit cards can give your organization more flexibility, it can also lead to headaches. You need to be able to track each individual’s usage separately to ensure it is appropriate. You also need to coordinate overall usage so the company does not exceed its credit limit.

Pros and cons of business credit cards

The following are some of the chief pros and cons of business credit cards:

Pros:

  • Flexibility for short-term cash flow needs
  • Separation of business from personal spending
  • More ability to accommodate multiple users
  • Business-oriented reporting tools and rewards

Cons:

  • Higher interest cost than other forms of borrowing if you carry long-term balances
  • Annual fees, in many cases
  • Their flexibility can make off-budget spending too easy
  • Requires regular monitoring of usage

What to think about when choosing a business credit card

Business credit cards offer different terms and features. Trying to weigh the overall attractiveness of the various characteristics of a business credit card depends on how your company is going to use it.

Before choosing, consider how your business will use its credit card. That will help you evaluate the following:

  • Interest rate. Consider both the introductory rate and the ongoing rate. The relevance depends on whether you expect to carry a month-to-month balance that will incur interest charges.
  • Annual fee. The lowest fee is not necessarily the best deal for your needs. You have to measure the cost of the fee against the interest charges you are likely to incur and any rewards you are likely to earn. Other features may also justify a higher fee if you find them useful.
  • Rewards. The type of rewards offered (cash back vs. points for specific types of purchases), how you earn them, and the amount of the rewards all contribute to how much those rewards will be worth to your business.
  • Credit limit. Make sure you choose a card with a limit that is more than adequate for your needs. Having a card declined because you have hit the credit limit can be a logistical headache and damage the company’s reputation.
  • Reporting tools. Consider what information the account will provide and how this will help you with expense tracking, budgeting, and taxes.

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Business credit cards as a tool for your company

The best way to use a business credit card is as a short-term cash substitute rather than a long-term borrowing source. With careful management, a business credit card can help you manage cash flow more efficiently. It does this by making credit readily available, consolidating expense payments, and providing a straightforward way to track business spending.

bright yellow light bulb

In a nutshell

Business credit cards can be beneficial for managing short-term finances and building creditworthiness. Their dual functionality facilitates expense consolidation and fosters responsible spending habits. However, prudent oversight is crucial to prevent overspending and maintain a positive credit standing.

Harnessing the potential of business credit cards demands strategic planning and disciplined execution. Leveraging their benefits while mitigating associated risks ensures sustainable financial health for your enterprise.

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