I was reading the articles about the new credit cards law recently, and it struck me – people don’t always know what credit cards are and how to use them for your benefit!
Many people think credit cards are source of all evil, and claim they will never use them, and stay with the debit cards (which, if misused, can cost you a lot). Others – use the credit cards like its some kind of cornucopia, and never think about the day when they’ll have to actually pay it all back.
So, in a nutshell – what are credit cards?
These are accounts (represented by plastic cards) that allow us using money that we don’t really have for purchases. They usually provide us with a certain credit limit, and charge money (interest) if we don’t pay them back the credit that we used.
Credit cards are a major (and for some, especially younger or new to the US financial system, people – the only) part of our credit history, which allows potential creditors determining whether we are creditworthy or not.
So how should we handle credit cards in order to get the best of the advantages, with paying the least fees and charges?
Well, here are my rules of the “correct” credit card behavior. They’ve proven themselves over the years, and I believe anyone behaving as described below – will get the most benefits out of his or her credit cards.
1. Always pay your credit cards in full. What does it mean? It means that you pay back for all the purchases you made, every statement cycle. Never carry a purchase over cycles, as it will start accruing interest from the date of the purchase, and moreover – you’ll pay interest on all the other purchases from that time, in many cases. It is tempting to buy more than you can actually pay back, if you have a large credit limit. It is very easy to find yourself on a shopping spree, getting full bags from every store buying things you’ve always wanted. But it comes at a high price, and many Americans are in financial troubles because of exactly that behavior. So, always pay your credit card in full. Remember – credit card is virtually the most expensive loan you can get. Some credit cards allow separating specific purchases and paying them over the cycles, so that only those purchases accrue interest. That can be useful for large one time transactions (for example, buying new appliances), but make sure your credit card does in fact allow that. Otherwise use services like Bill-Me-Later, not a credit card, for purchases you want to repay over time.
2. Keep your statement balance below ~30% of your credit limit. Keeping the credit vs debt ratio low helps you to establish good credit history and will make your credit score higher. If you need to make a large purchase, make sure to pay part of the money back before the closing date, so that the ratio between the balance on the statement and the credit limit will not be over 30%.
3. Always pay on time. Pay before the due date. All the credit card companies provide 2-4 weeks free of charge between the statement closing date and the due date of the payment. Make sure your checks arrive on time, and before the due date. If you’re late – it may not only trigger retroactive interest from the date of the purchase, but also a negative record on your credit record which may cost you a lot of $$ later.
4. Don’t have too many credit cards. Having too many credit accounts lowers your credit score, and may cause potential creditors to think of you as a person in financial trouble, who may default on a loan. So, every time you start filling out these department store card forms – think, if you really need them. It may not be worth the one-time 20% discount of the $20 purchase you’re making.
5. Use the most of the benefits. It can save you a lot of money. Learn what are the card benefits and learn how you can use them to save your hard-earned $$. For example, if you have a free rental insurance – make sure you don’t pay for it when you rent a car. If you get rewards – make sure to use the card that gives you the most rewards in the store you’re buying at.
6. Avoid fees. This is hard to someone who never had a credit card, but after a year or so with your first card, if you followed the first 5 rules, you’ll start receiving offers for credit cards with no annual fees, or membership fees or whatever. In my opinion credit card, like a checking account, should be free. They earn money from interest and charging fees from merchants, for which we’ll eventually pay, so they don’t need to take money from us too. If I’m getting an offer for a credit card and I see that it has a fee attached to it – I read no more, it goes directly to the trash bin. Of course, there are always fees for late payments, over the limit transactions, returned checks, etc. I call these “stupidity fees”. You should never get to a situation where you pay a fee like that, but if you got there – it’s your fault.
So, these are my rules for using the credit card. If you follow them, you’ll find that a credit card can be a very useful instrument. It allows you to consolidate your charges, be able to plan better and more efficiently your cash flow, helps you to actually save money (by cash-backs or rewards), and frees your wallet from all these bills and check books that make it so fat and heavy and easy to loose. And if you still loose it – it provides you protection so that no-one would be able to steal your money if found it.
So, I hope you’ll use my suggestions,
Your Little Advisor.