“Once you get into debt, it’s hell to get out. Don’t let credit card debt carry over. You can’t get ahead paying eighteen percent.”
Charlie Munger, Vice-Chairman, Berkshire Hathaway
For me, credit cards have always been a double-edged sword, a fight between good and evil, or in Biblical terms, a blessing and a curse. Growing up, my parents predominantly used cash, using their retail business’s checking account to pay bills. I was the first in my family to go to college and the first to have a credit card. My parents celebrated the former, and not so much the latter. They only accepted cash from their customers, refusing to believe in the benefits of the credit card. That’s where I probably get my reluctance to use credit cards instead of cash at times.
They may have been onto something though it may have been something else altogether. My mom, I still believe, may have been irked by the fact that women, on their own, could not get their own cards until the Equal Credit Opportunity Act of 1974 was passed. Before that, women needed to have a man (husband or father) cosign for a credit card. How was it fair that my Dad, not my Mom, the brains behind all our finances, could get a credit card? Just saying why I think my Mom, until the day she died in 2000, never had any interest in a credit card (pardon the pun!).
The Credit Card Landscape
Credit cards are a financial tool. But like buying a new buzz saw, you need to use it with care. Some people collected credit cards like baseball cards when I was growing up. That seems like a formula for disaster to me. Clearly we are not yet a cashless society with nearly 1 in 4 people unable to get approval for a credit card due to lack of credit history or discipline. Roughly 33 million people in the US are unbanked or underbanked, meaning they largely use financial products outside the banking system.
When COVID hit our shores in March 2020, new card applications dropped 40% from the first week of that March to the last week of the month as compared to the previous month. Inquiries for all kinds of loans–auto and mortgages–dropped substantially as our priorities were shaken to their core. The irony is that the use of credit cards increased out of necessity due to fear of touching cash on the risk of getting a coronavirus-related infection. That behavior is just another example in an already rich year of strange happenings.
Credit Card Statistics:
- About 176 million or 67% of Americans have a credit card with about 3.1 cards per person.
- The average card balance is $6,354 per person.
- Roughly 58% of cardholders carry some kind of balance.
- Average FICO score for credit cardholders was 703.
- The current credit card interest rate averages 16.03% but for people with fair (lower) credit scores, the rates rise to 22.84%.
- For new credit cards, the average rate was 18.78%.
Advantages of Credit Cards
Compared to cash, credit cards are a convenient financial product. Before COVID, retail businesses were increasingly not accepting cash from customers. Credit cards provide fast payments, transfers between accounts, and withdrawals.
There are far more shopping options with a card. It is easier to make, change, and cancel travel, hotel, and car rental arrangements. When traveling overseas, credit cards allow you to realize currency conversions automatically. Let’s face it, it is hard to carry a lot of cash–bills and change– around in your pockets jingling around. That said, I do like window shopping without my wallet so I don’t feel tempted to spend money unnecessarily.
2. Build Up Your Credit
For those who lack credit history, like young people, becoming an authorized user on your parents’ credit card is a rite of passage. This is a good way to build up a credit history so long as your parents’ credit scores are strong. Otherwise, it won’t help your credit situation at all. Most states do not have minimum ages for your child to become an authorized user. I’d suggest you teach your kids about responsibility in using a card safely and responsibly first.
Getting a new card may be a second chance to improve your credit score. You have missed payments, hurting your credit score in the past. If you are ready to be responsible, you should consider getting a secured card, putting some cash on account. You don’t need a massive number of cards to strengthen your payment history and length of credit history. Understand common credit mistakes and how to avoid them.
Related Post: 6 Ways To Raise Your Credit Score
3. Easy To Track Spending
Reviewing your credit card bills regularly helps you track your spending. It is easy to do (except when you know you spent a lot of money) and an excellent way to improve your financial discipline. Although spending cash is the best way to feel pain immediately, regular examination of the amounts you are spending is a realistic way to correct yourself. The credit bills serve as a receipt or a record of the purchase in the event of making a return.
One particular month, I recall seeing a very high bill with a number of items that seemed uncharacteristic of me. It was a posh store with a great salesperson. Looking around, I realized that the dress “I had to have” was still in the bag with the tags still on along with new shoes. Who did I buy that for? Not me apparently so I returned those things and stayed clear of that salesperson.
4. Automate Your Payments
Paying your bills, especially credit cards, are so much easier when you use the automation feature. Most cards have this feature that you can set on or before the due date so you are not late on your bill payments. Also, consider paying more than once a month if the lower amounts feel better to digest. As payment history accounts for 35% of your credit scores, automating payments is one way to help you not miss the due date.
5. So Many Perks
Having a credit card may entitle you to a host of perks. Typically, use of the card may allow you to earn a percentage of cashback, rewards, airline miles or points, discounts at eligible merchants, restaurants, theaters, hotels, travel insurance, welcome bonuses, early access to tough-to-get tickets, and free museum passes. Before signing up a certain perk, make sure it aligns with your needs. One time I ordered four tickets for Hamilton on Broadway for my family, only to realize they were preview tickets for the opening in LA, 3000 miles away. The issuer reimbursed us and waived the fees.
6. Protections For Consumers, Not Necessarily For Businesses
Credit cards offer several features for consumers. When you lose cash, it is gone forever. The good news is that cash is typically not attached to your personal information like the loss or theft of your credit cards. Some cards provide zero-liability fraud protection. In a fraud situation, just notify your issuer to cancel your card. Alternatively, the issuer can get you a new account number at no charge. Safety is important.
Typically, when you lose your credit card, your losses are capped at $50 so long as you let the issuer know promptly. There may be a higher fee and responsibility for any charges that aren’t yours if you delay reporting it. I once thought I lost my card so I called the card company quickly only to find that my card fell out of my wallet into a nook in my bag. Paying the fee was a fine for a lesson learned to at least look for your card first.
Cards often have spending limits. Occasionally, you may want to lift the limit if you know you may be spending more for an overseas trip, for example, where you plan to shop for jewelry. A cardholder can let their issuer know that they want to “opt-in” to allow for transactions that may put you over your credit limit. You can let them know the specific dates you’ll be traveling. Spending limits are a good feature, especially if you’re prone to overspending.
The Credit CARD Act of 2009 enhanced more protections for consumers that do no apply for businesses. With this law, issuers are required to notify consumers of significant interest rate hikes at least 45 days beforehand. Also, fees and charges, previously hidden, must be better disclosed clearly. There are some other practices that were improved with the CARD Act discussed here. Still, it is always important to read the tiny fine print, especially when it comes to credit cards.
Disadvantages of Credit Cards
1. Overspending Leads To Higher Debt
Spending beyond your means can be the root of all evil related to your finances. Credit cards enable people to shop impulsively. Having a card rather than a finite amount of cash gives you the ability to borrow more than you should. This leads to carrying high-cost debt on your balances. This can be overwhelming.
The convenience of using credit cards as compared to cash may encourage higher spending according to studies. In the now-classic MIT study by Drazen Prelec and Duncan Simester, MBA students held an auction to tickets to sporting events. One event was a desirable basketball playoff game and the other was a regularly scheduled baseball game. Those participants encouraged to buy tickets using credit cards spent up to 100% more than those who paid in cash. They called this the credit card premium.
Other studies seem to validate the MIT findings that we tend to spend more with a credit card than cash. For me, spending cash gives me an immediate pain as opposed to a nearly month delay of having to pay my credit card balance. to me mental accounting bias and overspending
2. Irresponsible Use of Your Credit Card
When you pay your card bill in full each and every month, you are not charged any interest. Your credit card provides a lot of benefits without the pain of paying high-interest costs. Unfortunately, many people just pay the minimum amount due at the end of the month, carrying a balance forward. That is all that is required by the issuers who prefer their cardholders to carry balances that feed these companies.
At an average balance of $3,000 with an average interest rate of 16%, it can take 16 years to pay off that balance at the monthly minimum rate which is roughly 3%-4% using a credit card interest calculator. That assumes that you haven’t used a credit card during those years. It is a vicious cycle. The magical powers of compounding that work so well when investing or saving for retirement works against you when you are paying interest charges on interest accumulated. If you cannot use your card responsibly, you should work hard to reduce your spending. Some people have too many credit cards, maxing out their limits, losing control of their spending.
Watch out for the particularly punitive penalty interest which may be imposed when you are late on your credit card payment. The penalty interest rate could be as high as 29.99%, above your regular interest rate, and may stay in place for a period of time.
3. Lower Your Credit Score
Just as you may be able to raise your credit score, misuse of your credit cards can destroy your score. Missing payments, applying for credit too many times, and using more than 30% limit of your available credit all can hurt your scores. Even closing a credit card account you don’t use will result in a decline in your score. Your credit score reflects on your creditworthiness to lenders, landlords, and other professionals and could impact you negatively.
4. Read The Fine Print
Just like any contract you sign, make sure to read the terms and conditions of the credit cards you are considering. Despite legislation to protect consumers, issuers are well known for hiding information about their perks, fees, charges, and other liabilities that you should know about. In recent years, consumers have been able to compare credit cards more easily. Among my favorite sites are WalletHub, NerdWallet, and CreditCards.com which have a ton of good information on credit card features.
Be aware that if you have a dispute with your card issuer, you are usually subject to mandatory arbitration. This has been relaxed in recent years but is still buried in the terms and conditions. It is one of my pet peeves and a project I assign my law students to look at the fine print. The average consumer can’t fight the legions of arbitration attorneys that support card issuers.
Exercise Financial Discipline By Using These Rules:
- Shop wisely for a credit card, finding the perks that most suit you.
- Read the terms and conditions carefully even after you made your selection.
- Pay your credit card bill in full so you don’t carry a balance.
- Have an ample emergency fund so you don’t put large unforeseen costs on your card.
- Spend below your means always and make savings and investing a priority.
- Don’t close any credit card. Instead, cut your card in a million pieces or simply put it in a drawer.
- If you have multiple cards, decide how to use them for different categories and don’t max out their limits.
- Avoid cards with annual fees unless they have important features you will use.
- Don’t get addicted to credit cards. Limit the number of cards you have.
- When it comes to paying your card bills, automate and don’t procrastinate. The penalty rate is punitive for a reason.
- If your child is an authorized user of your credit card, teach them about how to use the card wisely and safely.
- Be aware of behavioral biases of spending more when using your credit card instead of cash.
- Review your credit card bills for errors, poor judgment on your part, or to correct impulsive spending.
- Once COVID goes away, hopefully soon, use cash for some of your discretionary spending.
Credit cards serve an important purpose as a financial tool in an increasingly cashless society. Used wisely, the advantages of credit cards will outweigh its disadvantages. Exercise financial discipline in all aspects of money management. We have had our druthers about using credit cards, learned a hard lesson or two.
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With a passion for investing and personal finance, I began The Cents of Money to help and teach others. My experience as an equity analyst, professor, and mom provide me with unique insights about money and wealth creation and a desire to share with you.