To Charge or Not to Charge? The Pros and Cons of Credit Cards
It sounds like a win-win arrangement on the surface. What could go wrong? You really want that new smart TV, but it costs a fortune. No problem … you have plastic in your wallet. Just whip out that credit card and charge the purchase so you can pay the TV off over time.
Unfortunately, it’s not that easy or cut-and-dried. That charged purchase might boost your credit score, or it might usher in your financial demise. It depends on you, your habits, and your understanding of credit card basics.
How Credit Cards Work
You’re not actually paying for that smart TV when you swipe your plastic – at least not yet. Your credit card company is giving the merchant the money, and it’s not doing it because it likes you and wants you to be happy. It’s in the business of making money, and it expects you to pay it back for the purchase plus interest.
When you use your credit card, all sorts of things happen electronically. Your lender must approve the transaction. Depending on the terms of your account, you might or might not be permitted to go over your credit limit, but you can be sure that it will cost you extra if you do. You might be hit with a penalty fee on your next bill, or it’s possible that the lender will hike up your interest rate so you’ll be paying more per purchase going forward.
Your lender will tally up all your purchases and apply your interest rate to the total at the end of your card billing cycle. It will calculate the least amount you can pay toward your overall balance – the “minimum payment due” – and send you a bill.
Theoretically, at least, you can whittle away at that television purchase in piddling little minimum payment amounts month after month, but your remaining unpaid balance will keep accruing interest so that television could easily end up costing you twice as much overall. Of course, you can make more than the minimum payment and this is usually a good idea.
Understand the Pros and Cons
Maybe you’re not eyeballing a new television. Maybe it’s Thursday night, tomorrow’s payday, you have $6 left in your checking account, and your kids need dinner now. Having a credit card available so you can hit the grocery store can be a real lifesaver.
But it’s a documented fact that having one makes spending easier. Use your card often enough, especially for big-ticket discretionary items, and you could be in over your head and buried in debt before you know it.
On the other hand, you can potentially make money – sort of – by using that credit card. Some cards come with rewards programs, so you’ll get points toward something else at reduced cost or even for free when you charge this or that. Airline miles, hotel rooms and gasoline purchases are just a few common perks.
Some cards will even give you cash back. Then again, you might be tempted to buy something you really don’t need just so you can accumulate points. Then those gifts aren’t really “free” anymore.
Credit Cards Vs. Other Cards
If you’re like most people, you probably have a debit card in your wallet, too. What’s the difference? A lot.
You’re not borrowing money when you use your debit card. It’s attached to your bank account and when you use it, your account is debited for the charge. You’re using your own money, so by definition you don’t have to pay yourself back or worry about accumulating interest charges on each and every purchase. If you purchased and are using a prepaid card, the purchase is deducted from the balance of the deposit remaining on the card.
Because you’re not borrowing, all this activity doesn’t affect your credit standing in any way. It can’t hurt your credit score, but it can’t improve or build it, either. As far as the credit reporting agencies are concerning, using a debit card is a non-event.
Credit cards offer another advantage that debit cards don’t. They’re just plain safer to use. If someone steals your debit card or PIN number, he or she has full access to your bank account or to the funds you used to purchase a prepaid card. Can you get that money back? Maybe. Eventually. It depends on the terms of your bank or institution with whom you have your debit card.
Count on it taking a while, however, and you might not have access to the money involved in the fraudulent transaction – your own money – in the meantime. Your bank will need some time to investigate the matter and make a decision as to how to sets things straight. And you must report the fraudulent transaction within 48 hours or you may not be entitled to reimbursement at all. That leads to the question, what if you’re simply not aware of the problem for a few days?
Credit card lenders will freeze these transactions while they look into the situation, and they’re very good at investigating issues of fraud. You won’t be without your own money while things get straightened out. And, you’re only liable for fraudulent charges up to $50 no matter when you report the problem.
The same applies if you have a beef with a merchant. If you don’t get what you pay for – the merchandise is faulty or not as advertised – you can call your credit card lender and have the charge reversed. Then the merchant should be more than glad to accept the return of the merchandise.
How to Get a Credit Card
OK, now you know the ropes. If you still want a credit card, you have to know how to go about applying for one. This part is actually very easy.
Just go online and complete an application, or do so at your bank. You’ll have to disclose your Social Security number (SSN) so the lender can check your credit, and you’ll have to report things like your income and possibly your employment history. You should have an answer within a day or two at the most.
Just be sure to do your homework first. Look into a variety of cards to find the one that best suits your spending habits and your needs. If you don’t travel a lot, you probably don’t need a card that awards airline miles or free hotel stays, particularly if that lender charges a higher interest rate or a yearly membership fee.
If you’re under 21 years old, federal law requires that you have a cosigner if you don’t have significant assets or income. If that’s not an option for you or if you’re turned down for credit, consider a secured credit card instead – not to be confused with a prepaid debit card.
You place a deposit with the lender with a secured card, maybe $500, and you get a “real” credit card with all the usual perks in exchange. These cards usually don’t come with rewards programs, however.
Your card will typically have a credit limit equal to the amount of your deposit. That deposit secures the card. If you default on your balance, the lender gets to keep the money. You must still make monthly payments on anything that you charge and your deposit stays intact as long as you do. The activity is reported to the credit bureaus so you can build or repair your credit.
Now Use It Wisely
If all’s gone well, you’re now the proud owner of a shiny new piece of plastic in your wallet. You’ll still have to understand a few rules going forward.
You’ll probably want to avoid making those minimum payments noted on your statements. Pay your balance in full each month if at all possible. This might help you dodge interest charges entirely with some lenders, and it will look great on your credit report.
There’s no rule that says you have to maintain a balance on your card, but if you do, it speaks to your creditworthiness if you keep it to about 30 percent or less of your credit limit.
Even if you find that you can only make a minimum payment in any given month, make sure the lender receives it on time. Other lenders are watching your activity via your credit report. Late payments – or worse, no payments – can really drag your credit score down.
When you need to use the card, use it to charge purchases – don’t take cash advances if you can avoid it. Interest typically begins accruing immediately on cash advances and it’s usually charged at a higher rate as well.
Also, read your statements. Go over them line by line every month when you receive them to make sure every transaction is one that you authorized. While you’re at it, check your credit report periodically, too. Notify the credit reporting agency and the lender if you find that misinformation is being circulated regarding your account.
So there you have it. Charge away – just know what you’re getting into and borrow responsibly.
Beverly Bird has been writing professionally for over 30 years. She is also a paralegal, specializing in areas of personal finance, bankruptcy and estate law. She writes as the tax expert for The Balance.