Credit cards: Pros, cons, and tips

I am frequently asked what my views are on credit cards and their usage. Do I need to have a credit card? Is it okay not to have one? How does one use a credit card in a financially responsible lifestyle? How does a credit card help my overall credit rating? What are some good credit cards to use?

I thought I’d address all of these things in a single post, just so it can easily be referenced in the future.

My Experience with Credit Cards
 When I was in college, I signed up for my first credit card at one of those convenient booths that credit card issuers love to set up on college campuses. They offered me some sort of small novelty item when I signed up, most likely a t-shirt and/or a frisbee.

The card arrived in the mail. I used it a small amount during my college years. When I left school, I was carrying a small balance on it.

It was during the post-college years when the balances really grew. I got married. I bought a car. We went on a honeymoon and a few other really nice trips. The credit card balance went up and up and up. I got another card or three.

We had a child, and that’s when things started to change. The needs of parenthood began to alter our lifestyle and our goals, and we eventually came to a tipping point. We paid off all of our cards and closed several of them.

Today, we have three credit cards between us, each of which is tied to a specific retailer that we use. All of the cards are paid off in full each month, so we enjoy the rewards without the drawbacks.

Do You Need a Credit Card?
 No one needs a credit card. Credit cards are merely useful tools that achieve several benefits, but also have several drawbacks. I liken credit cards to knives: they can be incredibly useful tools in the right hands, but incredibly dangerous in the wrong hands.

First, the positives:

They help establish a positive credit history. Unless you are never going to own a home, own a car, go to post-secondary education, rent an apartment, apply for a job, have insurance of any kind, or make any purchase without cash in hand, you’re going to want a positive credit history. Companies pull your credit report for all of the above reasons and many others. Your credit report is simply the easiest way for a business that doesn’t know you to establish that you’re a trustworthy individual, one who can get better rates on insurance or who can rent an apartment in a nicer building or countless other things.

They make many purchases very convenient. You can make purchases almost everywhere, usually with just a swipe of a card. Most online purchases practically require a credit card of some kind.

They don’t provide direct access to your checking account. If your credit card number is stolen, the thieves don’t have access to your checking account as they would with a debit card. Credit card companies usually do a very solid job in handling such theft.

There are rewards programs that can provide some real benefits to card users.

At the same time, there are negatives:

It’s incredibly easy to spend more than you think you did. Unlike cash, you don’t see the money disappearing when you use a credit card. That abstraction can make it very easy to spend more than your mental accounting tells you that you did.

It’s incredibly easy to get into serious debt trouble. Because it’s so easy to spend too much, it’s easy to put yourself in a situation where you can’t pay off your balance each month. That means you’re going to be carrying a balance, which means you’re going to be handing interest payments to the bank. Bye bye, money.

If you’re not prompt on your payments, you can get hit very hard. Late payment fees are painful. The accrued interest from not making prompt payments is painful. If you’re not ready to be very diligent with your payments, credit cards will eat up your cash.

Is It Okay Not to Have a Credit Card?
 Absolutely. Many people live just fine without a credit card, typically relying on checks, cash, and debit cards to manage their finances.

What’s the drawback? If you go this route and have not incurred any other form of debt recently, you’re going to have a pretty sparse credit report. This shouldn’t negatively impact things like insurance rates, but it might make it more difficult to eventually get a home loan. If you’re thinking about getting a home loan in the future, you will want to start establishing positive credit now rather than later, and a credit card is a simple way to do that.

Using a Credit Card Responsibly
 There are some basic tactics that you can follow to minimize the negatives of a credit card while maximizing the positives.

Keep careful track of what you’re putting on the card. It is incredibly easy to forget about purchases once they’re on your card. If you forget about a purchase, it becomes easier to make another one, and then it becomes really easy to get into credit card debt. My suggestion is to strongly restrict which puchases you use the card for. For example, if you have a card associated with your gas station of choice, use it just for gas. If you have a card associated with your primary retailer, just use it there. Then, keep track of all of those receipts.

Pay the balance in full every single month. By doing this, you’re ensuring that you’re not paying interest on your credit card balance. Interest on a credit card is essentially money you’re just giving away to the bank, which is poor personal finance planning. It also ensures that you are staying well within your means with overall spending.

Use your credit card statements to identify spending concerns. If you do use a card for a wide variety of purchases, use the statements you receive in the mail to identify wasteful spending. Examine how many of the purchases on the card were for entertainment, hobbies, and non-essential food items, for starters. It often adds up to more than you think, and knowing is half the battle.

What Is a Good Credit Card?
 For starters, no credit card is good if you’re not using it responsibly, as described above. If you aren’t following those basic steps, then you should just avoid credit cards altogether. They’re going to end up costing you more than they’re worth.

If you are following those guidelines, there are a few things to really look out for.

First, don’t worry about the interest rates too much. If you are using a card responsibly, you’re paying off the balance in full each month. A credit card is not a tool for lifestyle expansion or spending beyond your means. It’s a tool simply for convenience and establishing a positive credit history while earning a small amount of rewards. If you’re doing that, then interest rates don’t really matter at all.

If you are finding that you actually are carrying a credit card balance with any regularity, then you should stop using the card.

Second, choose a card with a bonus program that matches what you’re already doing. For example, if you do all of your grocery and household shopping at Target, the Target REDCard is probably a pretty good choice, as it takes 5% off of your bill at Target. If you buy all of your gasoline at BP, the BP card is likely a very good choice for the gas discounts it provides. If you travel a lot, a card connected to an airline or to a hotel chain might be perfect for you, particularly if you’re a frequent customer of that chain.

On the flip side of that idea is cards that don’t complement what you do, which should be avoided. If you earn nebulous “points” that can theoretically be exchanged for goods, don’t bother. If you’re earning rewards towards a hotel chain that you never stay at, don’t bother.

Annual fees are a big thing to avoid unless you are really scooping up the rewards. For example, I have a friend who uses a Marriott Rewards Visa for all of his travel. He stays at a Marriott every time he travels and he racks up a surprising amount of free nights. He has to pay $85 annually for this card, but his calculation is that he’s getting at least a 7% return on his card usage.

Similarly, some cards charge other fees, such as account setup fees, program fees, and participation fees – avoid these unless you can make a very strong case that the rewards are going to be worth it.

I am strongly considering writing a series of articles on specific credit cards. These wouldn’t be included in the main flow of The Simple Dollar (so you wouldn’t have them filling up your email or RSS reader), but would instead appear as a separate subsection of the site, and I’d merely link to the latest ones in the weekly link roundup. The reason for doing this is to provide a central clearinghouse of unbiased thoughts on the various cards out there, as there are a lot of offers that seem good but really aren’t all that great and vice versa. Almost every card review I see seems to conclude that “this card is great for everyone,” and that’s just not true.

A Final Thought
 If there’s one thing you should take away from this, it is that credit cards are a tool of convenience, not a tool of lifestyle inflation. If you’re carrying a balance on your card, then you’re digging yourself into a hole that’s very hard to climb out of. You are far better off avoiding that hole entirely, and over the next year or so, you’ll have a lot more money in your pocket if you simply stay free from credit card debt.