If you are like most Americans, you probably have three to four credit cards you can pull out of your wallet at any time. Credit has become a way of life. The convenience is like no other, and with the ever-increasing threat of identity theft, the fraud protection they offer is typically unbeatable. The reward programs aren’t too shabby either.
At this time 38% of all households in America carry some credit card debt. Having said that, credit cards are an excellent resource for Americans as well. However, credit cards get a bad rap thanks to consumer debt continually rising. With that reputation are a few myths that just simply aren’t true.
Many people’s favorite financial guru is a huge proponent of this statement. Dave Ramsey has built an empire on this myth and is the king of cutting credit cards up. While he has great intentions, his audience is probably one of the reasons this statement exists. Typically we spend more when we pull out a credit card. If you’re down to your last $10, you may forgo the trip to Starbucks. However, if you’ve got a credit card with a $10,000 limit, you’re probably not going to deny yourself that Pumpkin Spice Latte; after all, it is the season of all things pumpkin spice.
Nevertheless, the most significant reason this statement is false is that it helps you build credit. And with good credit, the sky is the limit, or at least the credit line is the limit. You get the point! A good credit score lines you up for lower interest rates on cars, homes, unsecured debt, business loans, etc. It can even benefit you when it’s time to land your next job. Maintaining a stellar credit score shows you are reliable and what employer wouldn’t want that?
While payment history is a major factor when it comes to your FICO® score, it’s not the only component you need to worry about. How you utilize your credit is almost just as important. The number to determine your FICO look like this:
So it’s actually important to use the credit you have over the years. Additionally, you want to make sure you have a good mix of creditors—auto, home mortgage, credit cards, retail accounts, etc. The more you have, the better if it’s all kept in check.
Looking to buy a new car? Hoping to refinance a mortgage loan from the early 2000s? Then credit is king! Having loads of cash in the bank won’t hurt, but it won’t land you a low-interest rate like a high credit score will.
For example, let’s say you are looking for a 30 year fixed mortgage of $200,000. If you have a credit score in upper 700s you could get an interest rate below 4%—we’ll go with a 3.61% interest rate. That means your payments will be $910 a month; whereas a low score in the 600 range would drastically change that! Let’s say the lender gives you a 5.21% rate. Your monthly payments are now $1099. Almost a $200 difference per month! Additionally, that increase comes out to be $68,056 over the life of the loan. That’s a pretty significant difference. So don’t buy into the hype that your credit score doesn’t matter—IT REALLY DOES MATTER!
We all fall on hard times occasionally, however, if you end up here, do everything you can to pay your bills on time (that’s why I recommend an emergency fund). When it comes to credit cards, many carry a penalty APR—some as high as 25-30%. That means if you miss a payment your interest rate could shoot through the roof! Couple that with late fees and you certainly have a recipe for disaster!
Just to give you an idea of what I mean, let’s assume you have $5,000 on a credit card. You lose your job and can’t make the payments regularly. If you have a penalty APR of 25%, your debt now becomes $6250 plus whatever late fee they tack on. And that’s just in one month—imagine going for a few months! Talk about racking up the debt then! YIKES!
Credit card issuers give you a minimum payment, but if that’s all you are paying, then you will be paying for a looooooooooong time! For example, let’s assume you have a card carrying an $8,000 balance and the APR is 25%. Well if the minimum payment is 3%, that means you are paying $240 as the minimum payment. If that’s all you ever paid—we’ll assume you don’t charge another thing on it—that means in one year’s time you only paid your balance down by around $850 despite making almost $3,000 worth of payments. You’ll be paying on that for nearly five years—and remember that means you don’t charge another dime.
Pay your balances off. Instead of investing in the market take that money and get out of debt. If you don’t want to take my word for it, take billionaire Mark Cuban’s. He recently offered this one piece of advice on Business Insider, “Credit cards are the worst investment that you can make. That the money I save on interest by not having debt is better than any return, I could possibly get by investing that money in the stock market. I thought I would be a stock market genius. Until I wasn’t. I should have paid off my cards every 30 days.”
There are other strategies to employ before you choose the bankruptcy route. Try these first:
Well, there just isn’t a lot of truth in this statement at all. Now, I understand if you are not someone that can responsibly handle credit card debt, then the perks of owning one may be lost on you. However, if you pay your balance in full each month, using credit cards can actually pay you! Many cards offer cash back rewards, while others appeal to the frequent flyers with airline perks. Whatever rewards you like, there are advantages to utilizing credit cards.
I personally have received cash back this year, yet not paid a dime in interest. I even have a client that uses his card for business purposes. Because he pays it in full each month, he hasn’t paid any interest, but he has taken his family on vacation for the last several years thanks to his credit card perks.
Fraud protection is yet another advantage to credit cards. If someone gets your number or if you lose your card, many card issuers are quick to fix it without holding you accountable.
While credit cards seem to be the devil’s advocate, they can actually be used for the greater good as well.