For some, credit cards brought them into serious debt and still keep them there. For others, a credit card is a tool to improve their credit score. Is it wise to keep a credit card? How do you use one without getting trapped by debt?
Many people will find a credit card a useful tool in their personal finance toolkit. But it’s vital to learn the rules for responsible credit card use.
Advantages of a Credit Card
Having a credit card, if you use it responsibly, can boost your credit score. Many people assume that borrowing money will hurt their credit, but in reality, your credit score reflects that you have a good record handling debt. That includes using your credit card and paying your bill promptly.
A high credit score can help you when applying for a mortgage, getting a car loan, and even getting a good apartment. People use the number as a proxy for how responsible you are as a person—which can disadvantage debt-free, responsible people. Having a card you carry for a number of years and always pay promptly can tip off potential landlords and lenders that you know how to pay your bills.
When cash gets stolen, it’s gone for good. When a debit card gets stolen, the thief can withdraw money from your account before you know it’s missing, and you’ll have to fight to get the money returned. But with a credit card, you can dispute any unexpected charges before you pay your bill.
Laws limit the amount of liability you can have for a stolen credit card. If your information was stolen, not the card itself, you don’t have to pay anything. If the physical card was stolen, you may be liable for up to $50 of the theft. The rules for stolen debit cards are much less favorable, and if you don’t report the theft promptly, you could be liable for all fraudulent charges.
Some credit cards also have extra protections, such as refunding your money if the store won’t accept a return, or offering extended warranties on certain purchases.
What if you get paid on the first of the month, but an important bill is due the thirtieth? What if you need to pay a tow truck, but it will take a few days to transfer money from savings? Or if you’re stranded at the airport and need a hotel right away? A credit card can buy you a little time to pay that bill.
We’re not recommending carrying a balance on the card for months, but since you pay for your purchase when the credit card bill comes, you have a few weeks to transfer money around as needed. That can make it an important source of emergency funds.
Credit cards are easier to use than cash and easier to monitor than a debit card. Instead of having to worry about the exact amount in your account on a given day, you only need to make sure you will have enough money to pay the credit card bill when it arrives.
Most stores accept credit cards, and you may be able to use yours internationally. Many cards automatically change currency for you without a fee.
Lastly, you may need a credit card number to reserve a hotel room or rent a car, so the business can charge the card if you damage their property.
Disadvantages of a Credit Card
Interest rates on credit cards are much higher than on other types of loans—averaging about 15%. If you keep a balance on your credit card and only pay minimum payments, you could end up paying more in interest than the original products cost.
And if you keep charging more items every month without paying off your balance, your debt will grow rapidly.
Many credit cards come with fees. Some have an annual fee, especially if the card has perks. Some will charge you for transferring a balance over. You may be charged for making a foreign transaction or taking out a cash advance. And if you ever pay your bill late, you’ll be hit with another fee.
Temptation to Overspend
Since you don’t have to have the money before you swipe your card, it can be tempting to spend more than you would have with cash. It’s easy to convince yourself that you’ll be able to get the money before the bill arrives, or that you’ll be able to pay off the balance in a few months.
Studies have shown that people spend more with a credit card than they do with cash. But you can avoid this pitfall by setting a budget. You know how much money you have to spend each month. Whether with cash, debit, or credit, never spend more in any category than you have budgeted.
How to Use Your Credit Card Wisely
The biggest piece of advice experts give is to pay all balances every month. If you pay your balance every month, you’ll never have to pay the high interest rates on your card. When you pay only the minimum, you’re mostly paying interest and not reducing your balance very much. It can take years to pay off a balance at that rate! Instead, pay off as much as you can—ideally all of it. If you can only pay ahead on one kind of debt, always pay off credit card debt first.
Next, keep an eye on your fees. If your card charges fees for certain kinds of transactions, like international purchases, keep a tight limit on those. Always pay on time to avoid late fees. And if the annual fee of your card is high, consider switching.
Look at your statement every month so you can track your spending and report fraudulent charges immediately. If you’re often going over budget, you should work on your spending. If you’ve earned any perks, like miles or points, make sure to use them before they expire.
Finally, don’t max out your credit card. Not only will borrowing money up to the limit make it hard to pay down the balance, but getting close to your credit limit will hurt your credit score.
Is a Credit Card Right for You?
For most people, a credit card is a useful financial tool. For a few, it’s only a temptation. Should you sign up for one? What card should you get?
These are questions a financial advisor can help you with. To speak to an expert, contact us today!