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People often think credit cards are bad because of high interest debts and the risk of overspending. It’s true, if not managed properly, credit card debt can quickly spiral out of control, leading to financial stress, or worse. Additionally, the fear of incurring various fees also makes people fearful of using credit cards. At least that is what a friend of mine expresses when we discuss her personal finances.
Many credit cards offer reward programs that provide incentives to cardholders for making routine purchases, travel, and whatever the heart may desire. Cashback rewards offer a percentage of the purchase as cash, which can be deposited into your bank account or applied as a statement credit. Another popular reward is point-based. Cardholders earn points for every dollar spent which can be redeemed for travel, gift cards, merchandise, or statement credits. In addition, there are miles or points that cardholders can redeem for flights, hotel stays and other travel-related expenses. Retailer specific rewards is another popular program that provides special offers from the associated retailer or brand. If debt is paid in full each month, the cost of rewards is zero. But the cost of points or rewards if your balance is not paid in full each month can be substantial It’s no secret that Annual Percentage Rates (APRs) for credit cards can quickly reach thirty percent, or even higher depending on your credit worthiness.
Suppose you have a balance of $1,000 and your credit card has an APR of 18%. Assuming you carry the balance over, you could incur:
Monthly Interest: (18%/12) x100= 1.5%
Interest Charge for $1,000: $1,000 x 1.5%= $15 per month
If you earn 1% cashback, that is $10 in rewards on $1,000 in purchases. However, if you carry that balance for just one month and pay $15 in interest, you are losing money!
Despite the stigma associated with plastic money, credit card reward programs can be a great way to get extra value from your everyday spending. By understanding the different types of programs and considering your spending habits, you can choose the best card for your needs while maximizing your rewards.
With easy access to funds for an emergency, a credit card can provide a safety net. Not to be confused with an emergency fund which most professionals suggest is three months for an individual and up to six months for a couple. Using a credit card for emergency funds can be a double edge sword. You get immediate access to borrowed funds to the extent of your credit limit, however debt will be accumulated and carried over to the next months with interest and fees growing the debt.
Credit cards have safeguards designed to protect consumers from fraud, and unauthorized charges. Most cards provide something else of value, liability protection, which means you are not responsible for unauthorized charges made with your card. If someone steals your card information and makes a purchase, you will not be responsible for those charges assuming you report them promptly.
By now, you probably agree that credit cards provide some good benefits. But the barrier to entry will require good credit. Credit history and credit score are two fundamental components in the world of personal finance. They play crucial roles in your eligibility for loans, and housing. Your credit history is a detailed record of your borrowing and repayment activities. It includes information about your credit accounts, such as credit cards, mortgages, and car loans. Your credit history is compiled to create a credit report, which is maintained by credit bureaus – Experian, TransUnion, and Equifax. A credit report looks at five key elements. The first is payment history, showing whether you have paid your bills on time or missed any payments. The second, credit utilization, is a ratio of your current credit card debt to your credit limit. Keeping this ratio low is important. A good rule of thumb is to be below thirty percent. Third, length of credit history, considers how long the credit accounts have been open. A longer credit history is better. Fourth, types of credit, is having a mix of credit to show that you can manage different debt obligations. Fifth, recent credit inquiries, which occur when a lender or third party checks your credit score after you apply for new credit. Lending institutions will refer to your credit report prior to loaning you money because it is a comprehensive record of your financial behavior.
Finally, they offer other things, beyond rewards. To benefit from the best cards, credit score is important. A credit score is a numerical representation of your creditworthiness, derived from information in your credit report. The most used score is the FICO score, which ranges from 300 to 850. Higher scores indicate better credit worthiness. The FICO score is calculated based on payment history, credit utilization, length of credit history, and credit mix much like the credit report. Additionally, new credit is factored as opening several new accounts in a brief period can be seen as risky behavior. Maintaining a good credit score involves paying your bills on time, keeping your credit balances low, maintaining distinct types of credit responsibly, and avoiding unnecessary credit inquiries. You may be doing this without even realizing it. However, if balances start to carry over month to month, maxing out the credit limit, and payments start to be missed, or late the score will suffer. When you have a poor credit rating means there will be no extension of credit or higher interest rates, larger down payments, more collateral or the need for a co-borrower. Imagine you are the lender, just like any other risk, higher risk equals higher reward. If you are a higher risk to the lender than the next person, they are going to want a greater reward for taking a risk on you!
When used correctly, credit cards provide numerous benefits that make personal financial management easier and more gratifying. They are accepted almost everywhere, including grocery stores and internet retailers, making them highly convenient for routine transactions. Credit cards eliminate the need to carry large sums of cash. Responsible usage entails paying off debt in full each month, avoiding unnecessary purchases, and keeping track of your expenditures. Credit cards have become a vital element of modern financial life.
