Credit cards… the good, the bad and the ugly
8 out 10 Americans have credit cards and over half of those consumers carry a balance on their credit cards. With so much differing information out there, it can be hard to understand credit cards. You might even be thinking ‘Should I get a credit card’? Today, let’s talk about what you should know about credit cards and whether you should get one.
When used the right way, credit cards can be great. They can be used to build a credit history, raise your credit score, protect yourself, and accumulate rewards. On the other hand, they can lead to financial catastrophe. In 2017, credit card debt in the U.S. topped a trillion dollars! Yes, trillion with a “T”.
If you, like the majority of Americans, carry a month-to-month balance on your credit card we recommend that you STOP using them. We repeat, If you are unable to pay off your card in full each month you should NOT use them AT ALL. Go ahead and grab those scissors… it’ll feel better than you think.
Not sure if your credit score matters? Read our post about why your credit score can make a difference.
The problem with credit cards are the extremely high interest rates! These interest rates, which are usually well into the double digits, can even get as high as 25%. That new pair of shoes that cost $80 bucks can end up costing a couple hundred dollars in a very short amount of time once you start racking up interest charges. Using credit cards (or debit cards) also makes it very easy to spend more money than you realize.
If credit cards are the devil, why do we use them?
For starters, credit cards are one of the first ways Americans can begin to build a credit history. Credit cards can be beneficial when paid off fully each month. They can help establish and increase your credit score and you can accumulate points that can be converted to cash or other rewards. The key however, is to follow your budget strictly and not view your credit card as additional purchasing power. Use it like a debit card. As a refresher, a debit card is your ATM card and is linked directly to your checking account.
Secondly, in this day and age where Americans are purchasing a huge amount of things online, security is extremely important. One big reason to use a credit card is for the added security that a credit card can provide.
Lastly, using a credit card allows us to delay when we spend our money. What this means is that we are able to make a purchase we would normally make, but not have to actually pay for it for another 15 to 45 days later when the credit card bill is due. That delay could make all the difference if your pay check arrives later than expected. Or if you have an unexpected emergency arise. To be clear though, a credit card is NOT an acceptable replacement for an emergency fund.
Wait, doesn’t my debit card provide me security?
Yes, but the big difference here is that when you use a credit card, you are effectively borrowing money from the bank and then repaying them when your statement is due. What this means is that if your card gets stolen or used by someone else, the credit card company won’t hold you liable if you prove the charges are fraudulent and you notify them quickly. With debit cards, you are more likely to be held liable for the fraud. On top of that, your checking account money will be gone until the bank reimburses you for the fraud. It can cause a lot of problems if you suddenly realize someone emptied your checking account.
Lastly, cash back is nice to have. In our post on emergency funds, we recommended putting your money in a savings account with the highest interest rate you could find. We even told you that 1%, though it may seem small, can make a difference. Along that train of thought, if you’re going to spend your money each month on groceries or other routine expenses, why not use one of the credit cards that offers 1% or more cash back?
Wow, credit cards sound like a no-brainer, right?
Not for everyone. The security concerns sound scary, and they are. But the reality is that the big national banks will still not hold you liable for fraudulent transactions if you report the card missing immediately before charges are made. For many banks they will only hold you liable for the first $50 if you report the fraud within 2 days. This isn’t $0 but your emergency fund is there for a reason.
The data says it all. Far more Americans will be filing bankruptcy in 2018 due to a mountain of credit card debt from overspending than due to fraudulent expenses on their accounts. If you want to justify getting a credit card for the security benefits, this is not a good enough reason if you aren’t sure you will be able to spend responsibly.
In addition, if you normally use cash for a lot of your transactions, using a credit card for a cash advance at an ATM is extremely expensive. The interest rates on these withdrawals can go up to 35% which is shockingly high. To put that number in perspective, if you could earn 35% on an investment you’d have people ready to give you millions of dollars to invest.
How to pick a credit card
If you do think you are able to have a card responsibly and not carry a balance, look for a credit card without an annual fee! Some credit cards carry an annual membership fee which is simply not worth it for most people. Especially if you are new to the personal finance world.
Remember, we NEVER carry a balance on our credit cards. The rewards are simply not worth the interest rates if you ever carry a balance from one month to another.
Whether you are constantly driving long distances for work or your largest monthly expense is at the grocery store, look for cards that offer the highest cash back in the categories with your largest budgets. Having a credit cards that gives you 3x points for every dollar spent on travel when you don’t have plans to hop on a plane any time soon doesn’t make a lot of sense.
Are the rewards even worth getting a credit card?
Only if you can handle a credit card responsibly without carrying a balance.
Never spend more than you have budgeted for the month just to meet a spend minimum for rewards points or miles. That’s a big no-no.
Also, if you only have $50 remaining in your entertainment budget, but have a $1,000 credit limit, that does not mean you can spend a couple hundred dollars on concert tickets. Stick to your guns and only put $50 or less on the credit card towards entertainment and be sure to pay it off – in full – when the statement is due.
Just to emphasize the point again, if you cannot follow your budget 100% or have trouble with credit card debt, you should NOT use credit cards and should stick to cash (or debit). Period. Don’t forget that while credit cards are convenient, they can be very risky. Getting credit card points can be fun until you realize you might have to postpone your retirement for a few years to pay off your credit card debt. Now that sucks.
Do you know how your credit score is calculated? Read our post on how credit cards affect your credit score!