Credit Cards: Harness their Power, Avoid their Pitfalls

• Pros Of Credit Cards

• Cons of Credit cards

• Best Practices

Americans have reached a dubious pinnacle: $1 trillion in credit card debt. In honor of this questionable achievement, let's dissect best practices for credit card use, their benefits, and the traps that all too easily ensnare us. Like the element of fire, credit cards, when used judiciously, can heat your home; Overuse them, and they'll burn it down. For perspective, the stock market has historically offered annualized returns of 7%-10%, but the average credit card interest rate hovers between 16-21%, making credit cards arguably the best investment money can buy - but not for you. With 77% of American adults holding a credit card, it's imperative we understand how to wield this financial instrument responsibly. 

Pros of Credit Cards

Rewards for Your Spending

Consider all the purchases you make in a month: groceries, utility bills, Netflix, insurance. You're going to pay these every month, no matter what, so you might as well get something out of it, right? When you use a debit card or bank account, you pay your bills and get nothing in return. On the other hand, credit cards incentivize their use with rewards and benefits. Cash back, points, and exclusive cardholder benefits can all be yours simply by paying the bills you would pay anyway. It's a win-win situation where you can glean something more from your everyday expenditures.

Helps You Build Credit

The significance of building your credit profile cannot be overstated. The most impactful components of your credit score are payment history, credit usage, and length of credit history. A credit card can help bolster all three when appropriately used. Whether securing a mortgage for a home, applying for a rental unit, or any other type of loan, your credit score is often one of the first things lenders consider when deciding whether or not to approve your application or to determine what loan programs and interest rate you qualify for potentially saving you thousands of dollars in interest payments. Therefore, avoiding credit cards altogether could inadvertently hamper your financial capabilities and opportunities. 

Safety 

Navigating the digital economy and avoiding identity theft demands fraud protection, and in this department, credit cards are significantly better options when compared to debit cards. Suppose you have become a victim of fraud. If it occurs on your debit card, the unauthorized charges draw directly from your bank account, potentially resulting in bounced payments and a domino effect of insufficient funds fees that could tarnish your credit.

Recovering from debit fraud takes time as banks investigate, leaving you temporarily out of pocket. With credit cards, however, the scenario is vastly different. Fraudulent charges don't deplete your funds; instead, you report the issue to your credit card company and aren't held responsible for the transactions in question. Your cash reserves remain intact while the card issuer handles the fraud. This security feature isn't just a perk—it's a strategic advantage in safeguarding your finances and preserving your peace of mind.

Grace Periods 

Credit cards offer the option to finance major purchases or emergency expenses, allowing cardholders to distribute payments over time. This feature, while convenient, should be approached with caution, as every balance carried beyond the payment due date accrues interest.

Before resorting to your credit card for large expenditures, it is essential to assess the necessity of the purchase against the cost of borrowing and explore alternative financing options with lower interest rates. 

That said, a credit card can offer a credit limit beyond your immediate financial resources, providing the flexibility to manage cash flow without immediate financial strain, and is undoubtedly convenient and reliable if you find yourself in a pinch.  

Cons of Credit Cards

High Borrowing Costs

The average interest rate of a credit card is 20%, and the interest adds up quickly, turning what seemed like a manageable balance into a significant financial burden. This, coupled with the temptation of minimum payment offerings, is a trap that can send you spiraling toward a black hole of debt. In fact, if you only make minimum payments, paying off even a moderate amount of debt can take years. For example, a $5,000 balance at the current average APR of 20.28%, with minimum payments of $100, it would take over 9 years to pay off, costing a total of $11,200 in the end. 

Increase in Spending

Studies show that people have a tendency to spend more money when using credit cards than they otherwise would with debit or cash due to delayed accountability of payment, minimum payment options, and the lack of immediate impact on a person's bank account. 

Late Payment Charges and Annual Fees

Credit cards can introduce an additional layer of responsibility when not managed correctly. Beyond the standard late fees that come with most bills, credit cards add their own, often with a higher price tag. A late payment on a credit card does more than just cost you money in the short term — it can also have a long-lasting negative impact on your credit score since payment history contributes to 35% of your score; a few late or missed payments can have a sizeable negative impact. 

Depending on the credit card you have or choose to get, it may come with an annual fee to remain a card holding. These can range from $95 up to $700 a year. 

Best Practices

Two Card Strategy:

Card #1 Bills-Only 

One of the safest ways to incorporate a credit card into your financial routine is to dedicate it exclusively to your most predictable expenses: your cell phone, internet, insurance, and utility bills. This tactic also simplifies your finances. You'll have a clear expectation of your monthly credit card bill, allowing for straightforward budgeting and financial planning. Predictability can provide peace of mind and make it easier to take advantage of the benefits of credit without the stress of unpredictable debt.

Card #2 Discretionary Spending

Consider having a separate credit card for discretionary expenses such as dining out, daily coffee runs, clothes shopping, movie nights, and other non-essentials. This division allows for better tracking of your discretionary spending. By keeping these expenses separate, you can establish clear boundaries and quickly identify areas where you might be overspending. This helps you stay within your budget and avoid the slippery slope of credit card debt.

Not for One-Time Purchases

It's essential to be cautious and ideally avoid using credit cards for one-time, significant expenses. Interest rates on credit cards are typically much higher than those on personal loans, home equity lines, or borrowing from family, so the best practice is to explore other financing options before you swipe. Remember, a 20% interest rate is staring you down if you carry over the balance.

The rule of thumb is simple: "If you can't afford it with your debit, don't put it on your credit." There are exceptions for emergencies, such as an urgent car or home repairs, but for the most part, sticking to this guideline can prevent financial overextension.

However, if that emergency does come up, it is crucial to have a solid repayment strategy to avoid the high-interest debt cycle that credit cards can create. Paying off the balance promptly ensures that the convenience of credit remains a benefit rather than becoming a costly detriment to financial health.

Always Pay on Time

Strive to pay off your statement balance in full every month. This way, you get all the benefits without the pain of interest payments. If that's not possible, keep your credit utilization below 30% of your total credit line. Anything over that is considered a high credit utilization, which can negatively affect your credit score. 

Your Credit Card should reflect your life. 

With a plethora of credit card options at your disposal, it's imperative to conduct due diligence and select one where the benefits and incentives align seamlessly with your spending habits. By doing so, you ensure that the value extracted from any rewards program is maximized. Credit cards should not only facilitate your transactions but also provide a return on your routine spending.

Whether your expenses largely fall into categories such as dining or groceries, or you want exclusive benefits at that hotel chain you swear by or the retail store you can't resist, it's about making your credit card work for you, ensuring each swipe or tap not only pays for your purchase but also pays you back. The art is in selecting a card that mirrors your spending patterns and rewards you where it counts; it's not about the prestige of the card. It's about finding the card that offers a high rewards rate while keeping fees and interest to a minimum.

Set Up Auto-Pay

An effective strategy for ensuring timely payments is to set up auto-pay for your credit card and other bills. Automating your bill payments reduces the chance of forgetting and incurring late fees. When using your credit card within your budget, auto-pay allows you to rest easy, knowing your bills and credit card payments are taken care of. This convenience helps you build credit and enjoy the rewards, all without the need for manual intervention each month.

Remember, when you pay off your balance in full, you avoid paying any interest, keeping that 20% rate at bay and ensuring your credit card is a tool for your financial benefit, not a burden.

Conclusion: Mastering the Art of Credit Card Discipline

In a world where credit cards have become nearly as ubiquitous as cash, mastering their use is not just a skill—it's a necessity. With the specter of a trillion-dollar debt looming over us, the way we interact with these plastic powerhouses can define our financial futures. They are not inherently malevolent; it's our habits and choices that tip the scales between benefit and detriment.

The rewards are tempting, and the pitfalls are many, but armed with the right knowledge and discipline, you can navigate this high-stakes terrain. Treat your credit card like a strategic tool in your financial arsenal— one that requires respect, attention, and control. Use it to build and demonstrate your creditworthiness, simplify the management of your finances, and secure a more stable and prosperous future.

Remember, the fire of credit card use does not have to be destructive. Like the controlled burn of a skilled blacksmith, it can forge stronger financial resilience, build credit that opens doors, and provide rewards that sweeten life's journey. With vigilance and discipline, you'll find yourself not among the ranks of the indebted but standing tall as a paragon of credit card virtuosity.

So, take these lessons to heart. Let them guide you to make informed decisions that resonate with your personal and financial goals. Be steadfast in your commitment to responsible spending, timely payments, and strategic card use, and watch as the credit card transforms from a potential foe to a powerful ally.

Embrace the challenge, for it is those who are bold enough to master their credit card use who will reap the rewards—without paying the price.