Credit cards aren’t always problematic. Like a lot of financial tools out there, they can be beneficial if used properly and destructive if used improperly.
Knowing the difference between what you should do and what you shouldn’t do when it comes to how to use a credit card will determine whether your credit card ends up becoming a tool of convenience or a nightmare.
In this article, we discuss what you should know before getting a credit card so that you can use it without worrying about how it might negatively impact your finances.
A credit card is a piece of plastic that allows you to buy something without having to pay for it immediately. Instead, you’re billed later for the item you purchased. The main benefit you get from having a credit card is that you can purchase something without immediately having to pay out of your own pocket for the purchase.
Credit cards have many use cases, each tied to a specific benefit that they offer.
A credit card can be used as a way to earn rewards from making purchases. Many credit cards offer rewards programs that you can enroll in after receiving your card. Spend enough and you might qualify for a rebate on your purchases and/or reward points that can then be used to redeem certain rewards offered in your credit card’s rewards program. The benefit here is that you can reap rewards from spending on purchases that you would’ve made anyways.
A credit card can be used as a way to spare funds you have now for other purchases. Suppose, for example, that you need $100 now to pay for two crucial items. You know you’ll be getting $50 a week from now and you only have $50 now. A credit card can allow you to make the $100 purchase at no extra cost. That is, if you pay off that $50 you owe to your credit card company a week from now (assuming that’s when your credit card statement balance is due). The benefit here is that with a credit card, you can spend money that you don’t have now, which can be a useful ability to have for covering emergency transactions and avoid bank fees like overdraft fees in the process.
A credit card can be used to build a credit history. This is important because your credit history determines interest rates on loans that you might take out in the future. Have a great credit history and a long history of paying your credit cards on time? You’ll have the benefit of the best interest rates on any loans that you take out either now or in the future, which can mean significant savings for you on certain big ticket items that require a large loan, like a mortgage for a house. The benefit here is additional future savings assuming that you reasonably expect to take out a loan sometime in the future. If you don’t have a credit history right now, you may have a hard time getting a credit card application approved but there are also secured cards available that can serve as starting points.
While the benefits of a credit card can sound alluring, there are also potential downsides mostly stemming from misuse of a credit card.
For example, credit cards, by virtue of allowing you to spend what you don't yet have, can be used as a tool to overspend. Transactions happen quickly and can add up. If not paid off quick enough, this can lead to insurmountable credit card debt, with interest payments that you won’t be able to afford.
Therefore, before getting a credit card, know that:
Rewards are accumulated as a result of spending. If you control your spending, credit card rewards can be seen as “free money,” especially if your credit card rewards convert into cash rebates.
Do not let that fool you. If you look at the conversion rates from each dollar spent to each reward point accumulated, you’ll notice that only significant changes in spending lead to noticeable increases in the number of reward points accumulated. Once you find yourself enjoying those rewards, you might find yourself overspending again to qualify for greater and greater rewards. This can lead you down a path that ends with unsustainable credit card debt.
A credit card will not allow you to sustainably live beyond your means. That is because uncontrolled credit card debt can lead to high monthly payments that, if not paid off promptly can lead to even higher levels of debt (in the form of unpaid interest) that is even harder to pay off. A vicious cycle.
Each transaction that overdrafts your bank account costs you around $35. With a credit card, you can easily pay off a transaction that you need to make now without incurring a fee (assuming that your credit card is not maxed out).
A credit card is a tool. It allows you to spend now without immediately paying out of your pocket for your purchase. For some, this can offer great liquidity benefits.
By virtue of this same characteristic, a credit card can also allow you to spend more than you actually have in your bank account. By doing so, you are making a choice to spend more than you have.
You made the choice to do so, not your credit card. You may get pulled to spend on certain items that you would have otherwise not considered spending on, but the choice to spend is ultimately yours.
Card rewards are sometimes attached to specific spending decisions. Some cards, for example, will reward you more for spending at certain retailers; others might give you rewards for spending on gas for your car. Pay close attention to the rewards of each card, and don’t forget to evaluate your own spending habits so that you can make an informed decision about which credit card(s) can be most beneficial to you based on what you tend to spend your money on.
Your credit card utilization rate measures your spending as a percentage of your overall credit limit. A good rule of thumb to follow is to keep your credit card balance at less than 30% of your overall credit limit. Going over this percentage can appear as evidence to lenders that you’re overextending yourself and subsequently decrease your credit score. If your credit limit is too low right now and you find yourself constantly at a utilization rate of 30% or more, consider applying for a different card or having your credit limit raised. With the Harvest PRO Index™, you can keep track of your debt index to see where you stand.
A credit card doesn’t have to be a problem. If used properly, it won’t be.
Remember - if your credit card ever becomes a problem, understand that the root of the problem is the spending behavior itself. To prevent your credit card from ever becoming a problem, keep track of your debt utilization.
Compare the total dollar amount that you spend on average using your credit card to your monthly income. Understand what you spend most on, whether it is essential spending or not, and in what situations you tend to spend using your credit card without regard for the amount you’re spending. After all, what’s not measured cannot be managed.
So measure your credit card usage and regularly question your spending behavior so that your credit continues to be a tool, not a problem.
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