Updated Oct. 4, 2021, 12:12 p.m.
Nowadays it seems that credit cards are an unavoidable part of our life. Without an established credit history, life simply becomes more challenging. As it is one of the common ways to build credit, how is it possible that so many people run into trouble with credit cards?
We often hear stories about how people get into overwhelming credit card debt and might think that we should just stay away from credit cards entirely. While avoiding credit cards all of your life may be an overreaction, let's try to understand why people might have skepticism.
More than half of Americans with active credit card accounts don’t pay off their balance in full and end up accumulating interest at an average rate of 16.3%. In 2021, the average household had a revolving credit card debt of $6569, according to LendingTree. This means that by routinely carrying a balance, a typical American family could be paying an additional $1071 annually just from interest charges.
But the real issues begin when borrowers get behind on their payments. With lingering debt there would first be additional late penalties and higher interest rates, both of which worsen the cardholder’s debt problem. If it escalates out of control, the debt is sent to collections and possible outcomes include bankruptcy, having wages garnished, and a collection lawsuit. All of these could severely damage anyones financial reputation.
The information presented so far should not convince anyone in favor of credit cards, and it sounds like there is good reason to be skeptical. But most of the problems are actually avoidable. Having a credit card is incredibly useful, even advantageous, as long as the correct approach is taken. A good indicator that you are using credit cards the right way is your credit score.
Your credit score is a measure of the risk you pose as a borrower and predicts how reliable you are to make payments on time. Earning a good credit score can be beneficial in many ways. In order to benefit you must take control of your credit score and perform better than the average borrower.
The average credit card holder has a credit score of about 710, while a good score begins around 700. Excellent scores are above 750, and achieving a near perfect score above 800, though impressive, is not usually necessary. Typically your credit benefits will max once you reach a score of around 800, and anything in excess serves as a buffer. To raise your credit score, avoid making credit mistakes and follow the tips outlined ahead. To know your own score, check out Credit Karma for a free evaluation.
The first reason to have a credit card, and the one you have to be most cautious about, is that you can conveniently borrow money whenever you need it. This is the reason why credit cards exist in the first place. You may use a credit card to have cash in advance of a paycheck, but you should only do this if you are certain that you will be able to pay it off soon. Be aware that your credit score will be affected by the percent of your credit limit that you use and you accrue interest each month on any remaining unpaid balance.
Certain cards have perks associated with them, such as rewards points. These points accrue as you spend money in most purchases, especially for certain categories or during promotional periods. You may redeem these points for travel rewards or sometimes even receive cash back. This is done simply to incentivize your continued use of credit cards rather than debit or cash. This equates to “free money”, up to a few percent of what you spend, as long as you don’t pay more in interest. More on how you can entirely avoid interest ahead.
Credit cards can be thought of as a gateway towards borrowing since they are often the introduction to one’s credit history. You can begin to build your credit score by having and using a credit card. When you have good credit, you are more likely to be approved for loans and might also qualify for lower interest rate loans for your car or home. You might also improve your chances of getting a job or apartment. A credit check is often part of the tenant screening process to be approved for a rental agreement. All of these benefits and more are because the credit score you build represents your financial credibility.
One advantage of using credit credit cards is that they come with stronger consumer protections than for debit cards. If your debit card information is stolen, unauthorized purchases must go through an investigation before possibly being refunded. But having fraudulent charges reversed is no guarantee as it also depends if the seller is willing to refund. That is your money that you have lost immediately from your account. You may be waiting a while before you get your money back, and this time is valuable when you have bills due.
On the contrary, credit cards serve as a safeguard separating your bank checking account from theft. When fraudulent charges appear on your credit account, your money is not actually stolen from you. Criminals are spending the creditors money and you have time to report this activity before paying your bill. Rather than having the responsibility on the consumer it is up to the credit card companies to dispute billing mistakes and fraud. During the investigation process your funds are kept safe and accessible by you, even before creditors settle the issue and waive the unauthorized charges.
Believe it or not, there’s good debt and there’s bad debt, and credit card debt certainly isn’t the good kind. This really boils down to interest rates on the money that is being borrowed. Credit card rates are very high when compared to other types of loans. With rates that typically begin around 12% and can be as high as 36%, this kind of debt can easily spiral out of control. Loans that only have a few percent interest can be leveraged to have higher returns through investment, but this can be impossible with double digit interest rates. Only confident borrowers should accept cards with higher rates.
It may be obvious to some, but you shouldn’t spend any money that you don’t already have. This is a major reason why people accumulate debt in the first place, and perhaps the most important rule to not break. A snowball effect may occur when this kind of borrowing continuously happens. Interest will accumulate faster, and then people can’t make their minimum payments on time. This further escalates the debt problem and lowers their score.
There’s a misconception that you only need to pay off the minimum balance that is due to raise your score faster. As long as you have regular monthly use, it is not necessary to keep a balance to raise your score. While you will not have penalties, relying on making only repeat minimum payments is an easy way to ensure you get the shortest end of the bargain. This is because you end up paying interest on your average daily account balance. Pay as much of your balance off as you can and you are on your way to maximize your credit benefits.
Here is the big secret which makes proper credit card management easy. Treat your card like cash and immediately pay it all off. You can do this during a grace period before interest charges are applied. Yes, that’s right. Using a credit card will not cost you any interest as long as you pay the statement balance in full every month before the due date. This means you can quickly raise your credit score with minimal effort while getting rewards points, all without ever paying a dime in interest.
This group of borrowers who do not carry balances each month on their card are called transactors. Essentially, transactors reap the benefits of credit cards without taking on much of the risk. In contrast, revolvers are the majority group of borrowers who constantly pay interest because of their revolving credit card debt. Be a transactor, not a revolver.
This one simple rule is basically all you need to set you on the right path to having an excellent credit score. It requires consistency with your payments and paying attention to your balance, but you could also set up automatic payments to help. We hope that through this article you gathered some financial insight or curiosity towards improving your credit.
See how your score is calculated in the next section to get an idea of how you might improve it.
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