Using Credit Cards Wisely

Obtaining and appropriately using credit cards is an important part of building credit. Generally, the interest rate is comparably high because the loan is unsecured by collateral. Most credit cards have a grace period. If you pay the balance in full within the grace period, the interest is forgiven. If you do not pay back within the grace period, you are liable for all the interest charged from the moment you made the purchase. The key principle to make credit cards useful for your family is to pay them off before the grace period expires, every month without fail. In fact, I encourage you to pay your credit card bill the day you get it. This helps you avoid interest and actually helps your credit score.

Before applying for a credit card, it is recommended that you conduct your own honest self-assessment to gauge whether or not you consider yourself qualified to be a responsible credit card holder. Credit card debt can be devastating to your family’s financial health. Remember that although buying on credit means a delayed payment, you still have to pay it off. Furthermore, if you do not pay off your cards on time, you will have to pay the full amount plus large amounts of interest. It is almost always unwise to purchase anything with a credit card that you cannot pay off before the grace period expires. If you need to borrow money, it is better to get a loan with collateral so that you are saved from the high interest rates of credit cards. Think of your credit card as a more convenient version of cash: don’t spend money you don’t have. Pay it off regularly, perhaps the day you get the bill. Keep track of your spending to ensure you stay within your family budget. Using a financial app like mint.com can help you track credit card expenditures in real time. Those who cannot use a credit card in a responsible way should delay obtaining one until they can live by these principles.

Evaluating Credit Cards

If you carry a balance on your credit card (meaning that you do not pay off the balance due each month), you should select a credit card with the lowest possible annual percentage rate. Whether or not the card has a grace period is irrelevant because a grace period only applies if you pay the full balance each month. If you pay your credit card bill in full each month, you should choose a card with a grace period and a low annual fee. The APR is irrelevant because you never carry a balance. Financial websites like creditkarma.com and mint.com provide great resources for evaluating credit cards. Creditcards.com also provides useful information.

A good rule of thumb to maximize your credit score is to not apply for more than one credit card per year. Generally, we recommend having about two or three credit cards in active use at a time. When you stop using a card it is usually better to leave the account open because even though you don’t use it, having the credit line open will strengthen your credit score. However, if your card has a large annual fee, it may be better to cancel the card and take a small hit to your credit score. It is often difficult to obtain your first credit card. If you are denied, you could have a parent cosign for you. You could also get a secured credit card. With this option, you have a low credit limit and make a security deposit for the amount of the limit. After you establish a history of paying off your loans, the security deposit is refunded.

Appropriate Card Uses (Benefits and Drawbacks)

Although some popular financial advisors advocate not having a credit card at all, there are several benefits for having at least one credit card.

·       Emergencies: Credit cards can be useful when you don’t have cash on hand and need to pay for something immediately, such as an auto repair or an insurance co-payment.

·       Reservations: Credit cards can be used to guarantee hotel rooms, rental cars, and other rental items. This is especially important if you travel frequently.

·       Convenience: With a credit card, you can buy things over the phone or on the Internet. Credit cards make purchasing things very easy. They also provide you with a record of everything you spend, an important bookkeeping benefit.

·       Cash flow and timing: If something is on sale and you know you have the cash coming in a week, you can actually buy the item before you pay for it. In this way, you can take advantage of sales. (But remember, you do not save money by spending money.)

·       Free services: Often, credit cards offer rewards such as extended warranties, travel insurance, airplane miles, gasoline rebates, and cash rebates, which can reduce the overall cost of some items.

·       Credit score: As mentioned previously, buying on credit and paying off your credit cards regularly is important to building a strong credit score. It demonstrates to lenders that you are responsible and capable of paying off loans. Even if you do not have a large budget, making your purchases (groceries, clothing, textbooks, etc.) via credit card will build your credit over time. Then when you go to get a mortgage loan, you will have a lower interest rate because of your good credit score.

There are also some important drawbacks to be aware of when using credit cards.

·       Increased spending: You may not take as much time to think about how much you are spending when you use a credit card. Research has shown that, on average, people spend more with a credit card than they do with cash—sometimes as much as 100 percent more.

·       Losing track of spending: It’s easy to lose track of what you spend with your credit card. It requires discipline to track the charges you make.

·       Interest and other costs: Interest charges can range anywhere from 8 percent to 25 percent. In addition to these interest charges, you must take into account compounding periods, annual fees, and other miscellaneous fees, such as cash advance fees and balance transfer fees. Because of these fees, the cost of using credit cards is often double or triple the cost of using other types of loans.

·       Obligations on future income: Most importantly, when you use credit cards, you put obligations on future income. As you take on more debt, you not only obligate future income but you also limit future flexibility you may need if emergencies arise.

Danger Ahead

It is vital to handle credit appropriately because credit abuse can very quickly get out of hand. An alcoholic or smoker may think that one drink or one cigarette will not hurt. But soon it is two, then three, then a pack. Should any of the following danger signals occur, get your financial life together so that you can again be an effective household.

1. Are total consumer credit payments over 20 percent of your monthly budget?

2. Is an increasing portion of your income going to debt repayment?

3. Are your credit cards at or near their limit?

4. Are you always late on one or more bills?

5. Are you borrowing to pay for things you used to pay for with cash?

6. Have you taken out a new loan to repay an old loan?

7. Is your net worth decreasing?

8. If you lost your job, would you make it for 3–6 months?

9. Are creditors threatening to repossess?

If you responded “yes” to any of the above danger signals, take a moment to consider what you could do today to help yourself get back on track. If not corrected, credit-holic symptoms can quickly spiral out of control, resulting in serious financial consequences for you and your family. As an additional suggestion, review the above checklist with your spouse and discuss and resolve any problems together. If done in a spirit of kindness, this will strengthen your relationship as well as your finances! 

If you find yourself becoming addicted to the lure of buying on credit but still

want to build your credit score, don’t cancel your accounts. Perform “plastic

surgery” on your credit cards by cutting them up with scissors or running them

through the shredder. That way, you won’t be using the cards anymore, and

keeping your account open will still build your credit score slowly over time.

What do I do if I Lose my Credit Card?

You have probably heard horror stories about credit card fraud. Here is some critical information to limit the damage in case your credit cards are lost or stolen.

1.     First, inform your credit card company of the loss or theft immediately. You will then have no liability for fraudulent use. It is a good idea to have the toll-free number handy so you know whom to call. They will immediately cancel the cards you have and re-issue new cards, often sending the replacement cards the next day.

2.     If your credit cards were stolen, immediately file a police report in the jurisdiction where the theft occurred. This proves to credit providers that you were diligent, and it is a first step toward a possible investigation.

3.     Most importantly, call the three national credit reporting organizations (Equifax, Experian, and TransUnion) immediately to place a fraud alert on your name and social security number. This alert notifies any company checking your credit that your credit cards were stolen, and they have to contact you by phone to authorize new credit.

What is the Difference Between a Credit Card and a Debit Card?

When you use a credit card you create a loan that will be paid off later, preferably before the grace period expires. Money actually leaves your account weeks after you make credit card purchases. When you use a debit card the money for the transaction is withdrawn immediately from your bank account. In this way, debit cards are like checks—you must have sufficient money in your account when you use a debit card, or else the transaction may be declined. Debit cards can also be used to withdraw cash at network ATMs without fees (in the United States). When you use a credit card to withdraw cash out of an ATM you may incur substantial fees. Debit cards offer less protection in case of fraud than credit cards and usually do not offer reward points.

How this Applies to YOU…

When obtaining a credit card you should evaluate different cards and make an informed decision which card would work best for you (see http://www.creditcards.com/ or other sites to compare cards).  Never get a card just to earn miles or points, especially if it has high annual and other fees.  Never get a store card (e.g., Kohls, Dillards, Best Buy) just to get 10%-20% off your purchase!  This will hurt your credit and these cards almost never have good terms.

Make sure you aren’t spending more using credit than you would with cash or check.  Be careful of the warning signs, and know the symptoms, that you are becoming a credit-holic.  If you are spiraling out of control, take a step back to correct the spending and get back on track financially (which may include “plastic surgery”).

If you lose your credit card, follow the three steps above: 1) inform your credit card company, 2) file a police report, and 3) contact the three credit reporting agencies.  If you fail to act when you realize a credit card is stolen, you may be liable for unauthorized purchases.

The Bottom Line –

Appropriately using credit cards can help you build credit. If using a credit card, be sure you can pay it off in FULL every month.  Be honest with yourself and if you can’t use it as a tool to build credit but want it to purchase “wants,” don’t get a credit card.  First learn how to minimize your spending to live within your means and then get a credit card.  A credit card should only be used to make purchases you would make anyway via cash or check.

To learn more about these topics, visit www.mymoney.nmsu.edu and/or contact your local extension office to talk with a Family and Consumer Science extension agent. 

By: Bryce Jorgensen, PhD

Family Resource Management Specialist