The credit card is one of the most divisive products among all the financial tools available. Ask around and you’re sure to find people who pay all their expenses using credit cards as well as others who swear the products are the embodiment of pure evil. Opinions among financial experts and thought leaders are just as mixed. Dave Ramsey won’t even let customers pay for his products using credit cards, and his large following is adamant about the destructive powers of credit and the virtues of debt abstinence.
A credit card is nothing but a tool. Whether its effects are helpful or harmful depends on the skills and knowledge of the user, a person with the power to choose how to use the tool. Here is everything you need to know in order to make the most out of this particular financial tool, taking advantage of its benefits without falling into any traps. Here are some of the common traps for dealing with credit card rewards.
Credit cards are not for everyone. Like tools, in the wrong hands, they can be dangerous. If you have personality traits like a tendency to lack self control, if you’re in the process of repairing your finances, or if you’re not ready for personal responsibility, avoid credit cards until you are mentally and emotionally prepared.
What is a credit card?
Physically, a modern credit card is a rectangular piece of plastic, graphite, or a metallic alloy, that identifies a financial account. All contain a magnetic strip on the back, and some contain an RFID chip. An account number and the owner’s name or business name may be imprinted on the front.
Behind the scenes, the credit card represents a type of financial account. By using credit cards, customers can offers a bank’s money instead of their own to pay for a product or service today, and over time, they repay the bank. For the benefit of using someone else’s money, customers will often need to pay interest, as expected with other types of loans. This is where problems can arise. Using other people’s money is often preferable than using your own because it lets you keep your own money available for other purposes, but if you buy something with someone else’s money while not being able to repay that type of loan, the results can destroy your own financial future.
Credit cards are like DVRs for money. Digital video recorders allow users to “time-shift.” Television channels, at least for now, have regular schedules during which they air programs, but if you’re not free at 8:00 PM to watch The Big Bang Theory, your DVR allows you to watch the program from the beginning at your convenience.
When this is the philosophy behind the use of credit cards, users avoid financial problems.
How does a credit card work?
When you choose to pay with a credit card and you hand the card to a cashier or submit your card number over a secure internet connection, the merchant you’re dealing with validates your account and whether the bank will allow the purchase to go through. If everything looks good, your purchase is added to your credit account. Many companies are involved with each swipe of a credit card, and money exchanges hands between all these companies each time a card is used. Merchants pay fees to accept credit cards, and eventually the card-issuing banks receive part of this as revenue.
Once a month, the bank accumulates your credit card purchases and sends you a bill. The best option, and only option I recommend, for dealing with that bill is to pay in full by the due date. If not, you have to pay a minimum amount, determined by the bank, to avoid extra fees.
Even if you avoid extra fees, an interest fee will be added to what you owe the following month. Interest adds up quickly, and could make a $100 purchase cost $200 in total or more rather quickly. When this happens, it’s more than just time-shifting; it’s as if waiting to watch your 30-minute recorded show would require 60 minutes of your life.
When you pay on time and in full, the bank considers you a well-behaved customer, and will report this behavior to other companies that evaluate whether you’re a good borrower. You want these companies to consider you a good borrower, because it could have financial consequences in the future.
Banks, in their roles as credit card issuers, don’t want all users to be well-behaved customers. The companies profit from these customers, but the most profitable customers are those who don’t pay bills in full but are rarely late. Because of all this profit, some taken from merchants, stores often have no choice but to raise prices for everyone as a result of the increased popularity of credit cards.
Why do people hate credit cards?
Using a credit card makes it easier to spend money. Scientific studies have shown that people are more likely to complete a purchase if they intend to pay with a credit card than if they intend to pay with cash. Cash just seems more scarce, so people are more likely to try to conserve it. Credit cards don’t produce the same kind of psychological barrier.
Also, with cash only, you can never spend more money than you have. With credit cards, that’s easy. The bank doesn’t check your savings account before approving your purchase, they just check to make sure you’re under your credit limit — a total amount the bank determines you’ll be allowed to borrow at any one time — and the transaction doesn’t appear to be fraudulent. In fact, even if the transaction would put you above your credit limit, the bank will likely approve the transaction anyway just so they can charge you a fee for being over the limit.
As a result, people spend more money with credit cards than they would otherwise. This just creates more profit for the banks while making it possible for users to destroy their financial future. In practice, many people do let credit cards harm their financial future, and they do so without even realizing the mess they’ve made for themselves until it’s very difficult to clean up.
Credit cards are like hammers. Hammers can be a very useful tool. You can drive in more nails with a hammer than you can without, but you can also hurt yourself if you aren’t paying attention and smash your finger. Other see credit cards more like guns. Guns have only one purpose — to kill or maim — and likewise, the real purpose of credit cards is to create significant profit centers for banks.
What are the benefits of using credit cards?
With the potential for harm, why even use credit cards at all? First, the concept of using other people’s money for a short period of time. Time-shifting your money can come in handy if you need to buy food for your family today, a day before your pay check arrives (though this can create a dangerous precedent). Credit cards can also help you organize your expenses, but that’s only a minor benefit.
There are three major benefits to credit cards, without which, it wouldn’t be worth the hassle to use these products instead of debit cards or cash.
Credit cards create a barrier between merchants and your own money. If nothing else, credit card companies are good at handling fraud, and they create a line of defense between fraudsters and your money. You should always check the rules when you open a credit card, but in almost all cases, you are not liable for any unauthorized use of your credit card account. And unlike a debit card, unauthorized use doesn’t affect your bank account, so you’ll still have your money if you happen to need it for something else on the same day someone uses your credit card account.
If you pay with any other form of money and later have a problem with the store, you have more power when you use a credit card. If the store refuses to provide a refund and clearly should, you can tell the credit card company to reverse the charge. Stores have a bigger incentive to try to work with you to resolve the issue because too many of these reversals can result in problems for their businesses.
Extended warranties and protections. In most cases, buying a product or service with a credit card automatically gives you more choices if you have problems with the purchase. Many credit cards extend the manufacturer’s warranty. Some offer purchase protection, where if you damage the purchase in some way not covered by the warranty, the bank will replace it. In some cases, credit cards offer purchase price protection, so if a store lowers the price on a product within a certain time period after you buy it, the bank will refund some or all of the price difference.
Credit card rewards. This happens to be one of the best marketing tools of all time. In order to gain more users and more credit card transactions, banks offer a variety of incentives to encourage new customers to apply. The issuers entice customers with promises of sign-up bonuses, cash back rewards, airline miles, and 0% introductory interest rates.
The savviest credit card users take accumulating these rewards to an extreme. I’ve heard of people using credit card to buy money directly from the U.S. Mint, at cost, to accumulate miles or cash back. When banks offered savings accounts with better interest rates, I’ve heard of people using a 0% APR cash advance to earn and keep the interest on the bank’s own money.
The more extreme the tricks one attempts, the riskier it gets, and banks will do everything legally possible to cause you to make a mistake with your rewards. Just one mistake, like needing to pay interest one month, undermining the advantage of credit card rewards. Some banks in the past have “forgotten” to send bills. Some allow — and seems to be continuing to allow without properly investigating — mysteriously stolen rewards.
How do I qualify for and choose a credit card?
Just about everyone in the United States over the age of 18 with an income can qualify for a credit card. In some cases, an income might not even be necessary. For those who don’t have a credit history or an income, secured credit cards are available. For these cards, users need to place a deposit with the bank, and the credit is drawn from the deposit. This is a good way to build up credit history to qualify for an unsecured card in the future.
For consumers with a credit history and healthy income, the choices are much broader. Determine which credit card fits your needs based on the benefits. Some types were mentioned above, but there are more options at the bottom of this article.
Study credit card reviews from other customers and determine which card you’d like to sign up for. Read the terms and conditions, and understand the consequences of not using the credit card properly. Understand the fees, particularly if there is an annual fee just for owning the card. Complete the application, verify your identity, and in most cases, you’ll have your answer within the same day. Sometimes, you can be approved in a matter of seconds.
Choose a credit card that matches your needs. It can help to browse card reviews that pertain to the type of card that works for you.
- The best credit cards for 0% APR on balance transfers. These are good for eliminating balances on high-interest cards where you aren’t able to pay the full bill each month.
- The best cards for accumulating frequent flyer miles. If you travel often on a specific airline, having a card branded for that particular airline can help you save money on ancillary travel fees (like baggage checking) and airfare. These are similar to travel rewards credit cards, which often are more flexible.
- The best credit cards for earning cash back. Cash back is the holy grail of credit card rewards. They often provide the biggest benefit per dollar spent on the card, particularly for someone who doesn’t travel on the same airline frequently. Every purchase earns some form of cash back, sometimes up to a rate of 5%. In many cases, you can make your rewards go further by redeeming them in the form of a gift card for a store you had planned to visit anyway.
- The best gas rewards credit cards. My state is full of commuters who live here but work in New York City. New Jersey is perfect for gas rewards. Compared to other states, the cost of gasoline is low, but it’s a major expense in many residents’ budgets.
- The best credit cards for students. College students are at an impressionable age, and there’s some sense that they are not yet prepared to use credit cards responsibly, particularly without an income. Some cards in this category help encourage appropriate financial behavior by rewarding it. They’re often easier to qualify for without a credit history.
- The best credit cards for small businesses. Small business owners often have financing needs that differ from typical consumers. Banks address some of these needs by creating cards suited for business owners. They often provide cash back rewards tailored to a business’s needs, but also provide credit under the business’s name and help proprietors and CEOs separate their personal expenses from those for their businesses.
If you have any thoughts about what might be necessary for people to know about credit cards, please leave your comments here. This covers just the basics; there are tips for the more advanced credit card user that will be appropriate for savvier Consumerism Commentary readers.