Did you know that the average adult in the US has a total of $5,596 in consumer debt?
It’s easy to see from that statistic alone why credit cards get a bad rap. If you’re not careful with how you use credit, it could wreak havoc on your finances in a variety of ways.
You might rack up so much debt it will take you years to pay off. You might end up paying thousands in interest, to the detriment of your other financial goals. Your credit score might get damaged in the process. There’s a lot that could go wrong if you don’t use credit responsibly.
But here’s the thing: credit cards don’t have to be bad. Using a credit card doesn’t mean an automatic road to bad consumer debt. But you can end up with that outcome if you don’t educate yourself about your credit cards before you use them.
So start smart! Learn about credit and how your plastic works before racking up any charges on your account.
How to Use Your Credit Cards the Financially Wise Way
First, treat your credit card like a debit card. Don’t charge more than you can afford (no matter what your credit limit is). Be mindful of how much you have in your bank account so you don’t end up in a situation where you can’t afford to pay your balance. You want to be able to pay it off in full every month.
It’s also a good idea to keep your balance low. If you have a credit limit of $5,000, that doesn’t mean you should have a balance of $4,500 at the end of the month — even if you can afford it. How much debt you owe is factored into your credit score. If you max out your cards, your credit score may suffer.
It goes without saying you should make timely payments. If you don’t, you can get hit with a late fee and a ding on your credit. Set a reminder to pay your bill, or set up automatic payments.
Lastly, only buy what you need. This goes back to treating your credit card like a debit card. Credit is not free money. You’ll have to pay at some point or another. Only use your credit card for routine shopping and planned purchases within your budget.
Understanding APRs and Fees
There are a few key terms you should know when using credit cards. Being informed will save you from making some costly mistakes.
One of the most important things you should understand is the annual percentage rate, or APR. If you fail to pay your balance in full, you’ll be charged the APR on all or part of your remaining balance. This means what you originally purchased for $20 might end up costing you $25 next month.
As another example, if your credit card carries a rate of 20%, you’ll pay $20 for every $100 you charge. This is why paying your balance off in full every month is critical!
You want the lowest APR available, but beware of promotional offers. Some cards have low introductory rates for a year which increase afterward.
A number of credit cards, especially those that promise rewards or points, also have annual fees. This fee will be charged during your first billing cycle, although some products will waive the fee for the first year and start charging it in the second year. Read the fine print before signing up for a credit card if you want one without an annual fee.
Late fees also apply if you fail to make a payment within a certain time period (usually 21 days). If you’ve previously made timely payments, you may be able to get a late fee waived, but don’t count on it. Late fees are capped at $25 for first-time offenders and $35 for frequent offenders under the Credit Card Act of 2009.
What’s Up with Minimum Payments?
When you receive your statement, you’ll notice there’s a minimum payment you can make. Minimum payments look manageable compared to your balance most of the time, but you have to factor interest into the equation.
Any time you leave a portion of your balance unpaid, interest will accrue on that balance. If you continue making charges on your card, while paying the minimum owed, you won’t be able to catch up to paying your balance off.
A Word on Rewards Cards and Reward Points
You might have heard about the benefits of rewards cards. When you make purchases with a rewards card, you acquire points to redeem for travel, cash back, and other goods. Sounds like a nice deal, right?
Yes, but only if you follow the guidelines mentioned earlier. Don’t charge everything you can think of in the name of getting points.
Credit card companies are able to offer these bonuses because of people who use credit irresponsibly. They’ll end up having to pay interest on their balances, and the free money ends up not being free after all.
Keep in mind that credit card companies don’t provide you with a “deal” to be nice — there’s a reason they offer reward points. They earn a profit off the interest rates charged to those who don’t (or can’t) pay off balances.
Rewards cards and the points you can “earn” only benefit you if you limit yourself to everyday spending you already planned for. The moment you start charging more to your card in an effort to grab more points is the moment that rewards cards become a threat to your financial situation.
One Big Upside of Credit Cards
Credit cards come with many “safety” features that other methods of payment lack. When you charge something on your credit card, it doesn’t immediately deduct anything from your checking account and you’re not out any cash until you pay that credit card bill.
This is a good thing in terms of guarding against fraudulent activity and mistakes on your statement.
If you paid with cash, you may or may not get that money back. You can always dispute a charge on your credit card. And if you pay with a debit card? Remember, this is similar to cash and the money in your account is taken out as soon as that transaction posts.
If you’re a victim of fraud or want to dispute the charge, you may or may not get that money back.
Should You Use Your Credit Cards?
Many people are staunchly against using credit when you could stick with your debit cards or use only cash. And there’s a good reason for this: if you can’t manage your finances or control your spending, your credit cards can fast-track you into financial disaster.
But while that’s a possibility, it isn’t the rule for credit card users. There are many advantages and reasons why others prefer using credit over debit or cash.
As with many personal finance issues, there may not be one right answer as to whether or not you should use credit cards. If you’re struggling to develop good money habits, it might be smart to stick to cash or debit for now until you can better manage your money.
If you take the time to educate yourself about how credit cards work, do what you need to do in order to use them responsibly, and you already keep a budget and track all your spending, a credit card can be a useful tool in your financial toolbox.