Years ago, when I started my career in the credit card industry, I learned an important lesson. I was visiting with a vice president of the bank, and she made the comment that credit cards are a great way to pay for things, but a terrible way to borrow money. Many things have changed with credit cards over the years, but that bit of wisdom remains true today.
When I first heard that comment, I wasn’t sure that I understood what she meant. Isn’t using a credit card always borrowing money? What did it mean that a credit card is a great way to pay for things? Over the years, I came to appreciate the value of what I learned that day.
The Power of Credit Cards
A credit card can be a powerful tool in your financial plan. But like any powerful tool, if you use it wisely, you can accomplish great things. If you misuse it, you could be causing unnecessary damage. So just like training to use a powerful tool, understanding credit cards before you use them is vital to your financial success.
Most importantly, using your credit cards can be one of the quickest and easiest ways of establishing and building good credit history. By using credit cards well, you can demonstrate reliability that will earn you a good credit score. Having a good credit score is critical as they are used in so many ways in our society. Not only are scores used for making loans, but they are used by insurance companies, rental agencies, utility companies, and potential employers.
Credit cards offer convenience and security. They are widely accepted for payment around the world. You can avoid carrying large sums of cash, which can be lost or stolen. If you lose a credit card and report it right away to your bank, you are only liable for the first $50 of any fraudulent charges on the card (which most banks waive anyway).
Most credit card banks give you 30 days from the day they generate your credit card statement to pay the balance in full. That means you can use the bank’s money for a short period, interest-free, to purchase items. All these advantages of using a credit card make it an excellent tool to pay for things.
The Dangers of Credit Cards
For a long time, many people didn’t understand how much money they were paying in interest by only making the minimum payment on their credit cards. Eventually, legislation was passed that required banks to show how long it would take someone to pay off a credit card making only minimum payments.
Let’s assume, for example, that you have a credit card and make a $2,500 purchase. Let’s also assume that you make a change in your life and decide not to use that credit card anymore and want to pay off the balance. If the interest rate on the card is 19% and your minimum monthly payment is 3% of the balance or $25.00 (whichever is greater), it would take you over 10 years to pay off that balance. You would pay about $2,200 in interest during that time. In other words, you would pay almost double the price of the item purchased.
Once you miss the “grace period” and you haven’t paid the balance in full on a credit card, you will be charged interest until the balance is paid off. Interest rates on credit cards are one of the highest rates for debt. Minimum payments are set so that you pay mostly interest and just a little of the actual balance each month. Using a credit card to borrow money is usually not your best option.
Other Credit Card Fees
There are other reasons that borrowing in this way is not a good option. Never miss a payment on your credit card. Not only will you be charged a late fee, but it could also increase the interest rate. It will also negatively affect your credit score. It takes much longer for your credit score to go up than to go down.
Never take out a cash advance using a credit card. Most banks will start charging you interest from the date you take out the advance. There is usually a cash advance fee, and most banks charge a higher interest rate on cash advances. If you need cash, use your debit card.
A variety of credit cards have annual fees. Some cards with annual fees offer real benefits, such as airline miles or other rewards programs. These can be worth the added cost if they meet your lifestyle. However, do the math when it comes to annual fees and make sure the rewards are worth more than the fee. Some credit cards charge an annual fee and do not offer any rewards. Avoid these cards.
If you need to borrow money to make a purchase, don’t just automatically take out your credit card. Stop and think about your options. Ask yourself the hard questions: “Do I really need to make this purchase?” and “Will this really help me in the long run?”. Try saving money rather than using debt. If you do find you have a need and don’t have available resources, consider visiting with your banker about other options to meet your needs. Most often, other forms of debt will have a better interest rate. You will be more likely to meet your financial goals if you plan ahead.
The wise use of credit cards can make a big difference in your financial future. Using them properly can make your life easier and safer. Making poor choices with them can create a debt that can be difficult to pay off. If you choose to use credit cards, commit to pay them off in full each month and don’t use them to borrow money.