Credit cards can be great tools to utilize within your financial journey. By using a credit card responsibly, you can improve your credit score, receive benefits and rewards, and even have access to various perks. However, if used haphazardly, credit cards can carry many dangers and consequences.
In this article, we’ll explore the dangers and pitfalls of misused credit cards, how to avoid them, and how to use credit cards as a positive tool in your financial toolbox.
The Dangers
If used unwisely, credit cards can have a large impact on your financial health. A few dangers of misusing credit cards are:
EXCESSIVE DEBT
Misusing credit cards can easily turn into more than you bargained for. Using credit haphazardly can cause you to rack up unintentional debt which can easily add up to more than you can afford to pay back. A swipe here and a transaction there can quickly eat up your credit limit, maybe even before you realize it. Not only do you have to deal with the debt you just acquired but possibly even interest on that debt which can create an even bigger hole that you’ll need to dig yourself out of.
INTEREST
Most credit cards carry an interest rate. While some may have introductory deals and offer 0.00% APR for a set period, at some point interest will start accruing. You definitely don’t want to rack up a balance and then begin getting interest charged! If you do carry a balance while accruing interest, you could end up paying a hefty amount towards interest which only prolongs how long you will make payment.
According to Forbes, the average credit card interest rate is 27.65%. For comparison, the average personal loan interest rate is 12.22%. These rates will vary depending upon many factors such as the type of card, your credit score, and other terms. For example, if you had a balance of $1,000 on a credit card with a 28% interest rate, you could end up paying upwards of $1,600 in interest if you paid the minimum monthly payment. This is almost double your balance meaning you will pay for your transactions almost 3 times over before you pay them in full.
PAYMENT HISTORY
Payment history is one of the biggest portions of your credit score. If you mismanage your credit cards, you could put yourself at risk of falling behind on payments or even being unable to make your monthly payments. This not only affects your credit score but could cause fines and late fees which only increase your balance.
Something to keep in mind is that paying the monthly minimum payment will cause you to pay the most amount of interest and will take the most amount of time to pay back. On that same $1,000 balance, it would take you 132 months to pay back your balance and the interest on that balance in full when paying the minimum monthly payment of $33.
CREDIT UTILIZATION
Another contributing factor to your credit score is credit utilization, how much of your available credit is being used. Again, if you are mismanaging your credit card, that can easily drive up your credit utilization making it much harder to pay your balance and causing a negative impact on your credit score. Ideally, you want to keep your credit utilization below 30% as anything higher could be seen as an impact on your credit score.
While it is typically a wise idea to pay your balance in full each month, keeping an ideal credit utilization would look like not carrying a balance of more than $300 on a credit limit of $1,000.
It Doesn't Have to Be Negative!
If used responsibly and strategically, credit cards can be a great asset and aspect of your financial plan! Essentially, credit cards can positively impact each of the areas mentioned above when used correctly. Responsible credit card usage can even come with some perks in the form of rewards, points, and cash back! By using credit cards responsibly, you can:
AVOID DEBT
By using credit cards responsibly and having clear intentions with how you will utilize them, you can set yourself up for success and avoid debt. Some best practices to consider when planning to incorporate credit cards into your financial game plan are:
- Working them into your budget and ensuring that you don’t spend more than you can afford.
- Paying off your balance in full each month.
A great idea when looking to incorporate credit cards into your finances is to consider putting your everyday expenses like gas or groceries on your credit card. This allows you to work from the budget you’ve set for these everyday expenses and have a specific plan, so you know what to expect from each monthly cycle.
One thing to keep in mind when considering this approach, or really any approach to credit cards, is your spending behavior! It can be easy to utilize your credit card for these everyday expenses and overspend in other categories because you still see money in your checking account. However, it’s important to keep in mind that the money in your account will go towards your credit card balance and it isn’t just free money for other purchases! Keep track of your expenses, transactions, and monthly budget to ensure you are able to pay that balance monthly.
POSITIVELY IMPACT YOUR CREDIT SCORE
By using credit cards responsibly, you can positively impact your credit score through both your credit utilization and on time payments! These impacts not only have a positive effect on your credit cards but your financial health as a whole. Having a positive credit history can open up opportunities for future financial decisions and impact your future lending— even getting you a better rate and better terms on many loan products.
RECEIVE POINTS, REWARDS, AND MORE!
If you’re able to use credit cards responsibly and strategically, you may even be able to get points and rewards for those everyday purchases! While this looks drastically different from card to card, you can research and choose a card that rewards the things that matter most to you. Some cards offer rewards for specific types of purchases, some offer cash back on purchases, and some offer other rewards in the form of points such as airline miles. While these cards may not be for everyone, some choose to use them as they offer a return on purchases you are already making!
As you consider how credit cards may or may not fit into your financial journey, remember that it is entirely individual. No two financial situations are identical so researching and deciding for yourself is essential to setting yourself up for success. If you would like to talk through credit cards and what they might look like for you, schedule an appointment with one of our financial counselors today!
