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According to Dave Ramsey, “There’s no good reason at all to have a credit card. Despite what commercials, celebrity spokespeople, and the Joneses next door will tell you, responsible use of a credit card really doesn’t exist.” If you agree with Mr. Ramsey’s total disrespect for your ability to behave like a responsible adult, you probably shouldn’t carry a credit card in your wallet. However, if that described you accurately, you probably wouldn’t be reading this article… With that in mind, let’s see how you can improve your finances through using credit cards in the best ways, and avoiding the worst.
Credit cards are like a power saw. Use them right and you can easily do things with much less effort than without. Use them wrong and you can (figuratively, for cards) cut off your fingers (ouch!!!). Here are the best and worst ways to use your credit cards, and how in some situations one of the worst ways actually becomes best.
To be clear, credit card issuers are not in the business out of the goodness of their corporate hearts. They issue your cards and take the risk that you won’t pay what you owe them for the simple reason that on average they make a lot more money than they lose.
Once you get this, you’ll understand why things are done as they are. Everything is set up to maximize card issuers’ profits and minimize their losses. Since you’re the other side in the transaction, this means things are set up to maximize how much you pay. However, if you play your cards right (pun intended), you can beat the house, and here’s how to do that.
If you’ve used credit cards for many years, you can safely skip this section.
Credit cards are a tool that lets you buy things now but pay for them later. However, as they say, the devil is in the details, and here are the most important details.
Credit Limit: This is the most the issuer is willing to let you owe them, even for the short period until your next payment is due. If you try to charge something that results in your balance going over this limit, the issuer may decline to pay. This can leave you in an awkward situation, especially if you’ve e.g. just finished dinner and don’t have cash or another card to pay with. Even if the card isn’t declined, your card issuer will likely charge you an “over-the-limit” fee (more on that below).
Annual Percentage Rate (or APR): The card issuer sends you a monthly statement, asking you to pay them back what they paid merchants for your purchases throughout the month. If you don’t pay in full, they start charging you interest. The interest rate, or APR, is disclosed in the pesky fine print of your contract, and may change if the issuer notifies you. Another thing usually stated in that fine print is that interest starts accruing immediately on certain things, such as buying gift cards or paying off the balance on another card. That’s why the APR is important even if you plan to pay off the balance in full each month. The thing to know here is that credit card APRs are rarely the cheapest way to borrow money.
Minimum Payment: This is the smallest amount you must pay back each month to avoid serious negative consequences, such as penalties and lower credit scores. This is usually calculated as a percentage of your outstanding balance, any interest owed, any penalties or other fees, plus anything you owe that’s above your credit limit. If you’re maxed out and strapped, paying even this minimum can be very hard.
Annual Fee: This is what the card issuer charges you just for having their card. Most cards these days have a $0 annual fee. However, some types of cards, especially higher-end travel cards, charge hundreds of dollars a year.
Cash Advance and/or Balance Transfer Fee: If you use your card to get the equivalent of immediate money, be it by having your card issuer pay off your balance on another card, or by buying a gift card, your issuer will most likely charge you a fee calculated as a percentage of the amount they paid out, above and beyond paying immediate interest on these payments even if you pay off your balance in full every month. Note that some issuers offer teaser benefits when you first get their card, which could include 0% interest and no fees charged on any initial balance transfers, and this benefit may last for a year or more (more on this below).
Penalty Fees: As mentioned above, if you go over your credit limit, not only will you need to pay back that extra as part of your next payment, you’ll also have to pay an over-the-limit fee. If your payment isn’t made by the due date, you’ll be charged a late-payment fee. Since these penalties can be $39 each or more each time they apply, they may seriously accelerate your personal debt crisis.
Foreign Exchange Fee: If you use your card in another country, most card issuers will charge you a fee (usually 3% of the transaction value) above and beyond the value in US$ of what you were charged in the foreign currency. What may surprise you is that sometimes you’re charged this fee without ever setting foot outside of the US. This happens e.g. if you buy something online from a foreign company in their home currency.
Hopefully the above hasn’t already convinced you to stay away from credit cards because, like power saws, credit cards can be very helpful if used correctly. Among other things, if used well, credit cards build your credit history and raise your credit score, which helps you get better rates on mortgages or auto loans, get your apartment rental application approved, and even make your auto insurance cheaper. Some even give you free rewards like cash back.
Since nobody is born with a credit card in their name, and getting that first card isn’t the easiest thing in the world, what’s the best way for you to get yours?
Here are 4 of the easiest ways to start.
The best ways to use credit cards depend on your circumstances. Assuming you’re not in dire financial straits, here’s what you should do.
According to a recent Credit Penguin study (based on the most recent data, from April 2018), 41.2% of American households carry at least some credit card debt, on average $9,333. Looking at the poorest households, those with a net worth (what they own minus what they owe) of $0 or less, that average climbs to $10,307. If you’re a card-carrying member of that group, most of your best ways to use a credit card are quite different.
As mentioned above, 41.2% of American households carry credit card debt, and for the poorest of us, that balance is on average over $10,300. If you’re working full time at the $7.25/hour federal minimum wage, that $10,300 is more than 2/3 of your annual pay! This points out some of the worst ways to use your credit cards.
While the following isn’t something to aspire to, in certain dire circumstances it changes from a wrong way to the right way to deal with credit card debt. Specifically, if you’re at the end of your financial rope and can’t meet even your minimum payments, you have to seriously consider paying less than the minimum, or even nothing at all, to your card issuers. It isn’t the most ethical thing to do, but sometimes you have no good choices and have to choose the least bad option available.
For example, if you stop paying your mortgage, you’ll lose your house. Stop paying rent and you’ll be evicted. Stop paying utilities, and your electricity, gas, and water services will be cut. Stop paying your grocer, and you’ll have no food for yourself or your kids. When you simply can’t make ends meet, you have to prioritize. Weighing homelessness and/or starvation against defaulting on a credit card agreement and suffering lower credit scores, you have to accept that the latter just isn’t as dire, and lacking better options, it becomes the right thing to do.
However, breaking your word and your signed agreement should be done with some thought. For example, if there’s no way you can ever pay back your creditors, you should explore declaring bankruptcy so (most of) your debts are wiped off the books. However, you have to realize that the bankruptcy court will take whatever money you do have to pay part of what you owe, your credit score will plummet and stay really low for many years, and you won’t be allowed to declare bankruptcy again for years.
If things are bad but not quite that bad, contact your creditors proactively as soon as you realize you won’t be able to make timely payments of the minimum due. Negotiate with them options such as paying a lower interest rate, waiving penalty fees, etc. While they won’t do things out of the goodness of their hearts, they usually realize that they can’t squeeze blood out of a stone, and decide that their getting some of their money back from you is better than getting nothing at all.
If you’ve stuck with me to this point, kudos. Hopefully you’ve learned at least something that will help you use your credit cards like a pro, “beating the house” by taking advantage of what they let you do that makes sense in your situation, without paying for things you don’t have to.
What have you found to work best (or not work) for you in using credit cards? Do you think any of the above information would change that experience?
Disclaimer: The information in this article is not intended to encourage any lifestyle changes without careful consideration and consultation with a qualified professional. This article is for reference purposes only, is generic in nature, is not intended as individual advice and is not financial or legal advice.