Avoiding the bad of credit cards while harnessing the goodThose slim rectangles of plastic in your wallet are actually double-edged swords. Credit cards can be useful financial tools — to build a credit score and or earn cash-back rewards — but only when used judiciously. Otherwise it can be easy to fall into their traps, financial experts say.
By: Sherri Richards, Forum News Service
FARGO — Those slim rectangles of plastic in your wallet are actually double-edged swords.
Credit cards can be useful financial tools — to build a credit score and or earn cash-back rewards — but only when used judiciously. Otherwise it can be easy to fall into their traps, financial experts say.
“I think the No. 1 trap is it’s too convenient,” says Duane Emmel, a financial counselor with the Village Family Service Center in Fargo.
If money burns a hole in your pocket, a credit card will torch the entire body, Emmel likes to say.
“You’re not limited to the $10, $20 or whatever dollars in your pocket,” he says. “In visiting with people, they feel simply because they have credit cards and can use it, they have money. No, the credit card only allows you to go into debt.”
And on top of that, interest accumulates, especially when the card holder makes only a minimum payment on a card with a 24 or 30 percent interest rate. (“They always make it 29.9. Makes you feel better I guess,” Emmel says.)
In American households with debt, the average credit card debt is $15,422, according to November 2012 Federal Reserve statistics. Nearly 47 percent of U.S. households have a credit card balance, according to NerdWallet.com.
Calculations performed at Bankrate.com show if a family pays only a 2 percent minimum payment on that $15,422 (at 15 percent interest ), it will take more than 40 years (481 months) to pay off the credit card debt, and they will have paid $24,892.92 in interest. A fixed payment of $308.44 (2 percent of the original balance) will rid the debt in 79 months, totaling $8,931.19 in interest.
Another credit card trap people can fall into is paying additional fees without realizing it, Emmel says.
One example is credit card insurance, which would pay the holder’s credit card bills in case of a job layoff, though getting the policy to pay is difficult, he says. He’s counseled individuals who didn’t even realize they were paying for the insurance.
Many of the “gotcha” traps of credit cards were reined in by the Credit CARD Act of 2009, implemented into 2010, such as “universal default,” where a company could raise interest rates on customers based on their payment records with unrelated creditors. Emmel encourages consumers to review their statements to make sure the credit card companies aren’t still using these sorts of tactics.
But credit card terms can still come back to bite a customer, especially if the card is used for both balance transfers and subsequent purchases, Odysseas Papadimitriou, a former Capital One senior director who is now CEO of credit card comparison website CardHub.com.
For example, minimum payments are applied to the balance with the lowest interest rate. (Any payments above the minimum are applied to the higher rate first, thanks to the federal changes.)
Many cardholders don’t realize if they carry a balance on a card, their grace period – the 20 to 30 days before interest begins to accrue on purchases – goes away. Instead, the cardholder is assessed finance charges on those purchases from the moment they are made.
This eats away any credit card rewards the customer is hoping to earn, Papadimitriou points out.
“The credit card companies want you to use your credit card for more than one purpose,” Papadimitriou says. “The consumers should avoid that and compartmentalize.”
He urges consumers to comparison shop, and use an “island” approach – one card for one purpose.
People who want a credit card for everyday purchases that they’ll pay off in full each month only need to focus on the annual fee and rewards.
“You don’t care about the interest rate (because you’re not paying interest),” he says. Sometimes an annual fee pays for itself with higher rewards, he adds.
Consumers looking to transfer a balance onto a zero-percent card need to look at the balance transfer fee and APR. He says 3 percent is a common balance transfer fee, though there are cards with no transfer fee and zero percent interest for several months. That type of deal can save the consumer thousands in interest, he says.
For a big-ticket purchase that will be paid off over a few months, consumers need to compare the introductory APR as well as the regular rate after that.
There’s a fourth bucket of people, Papadimitriou says, who need to rebuild their credit in order to access these sorts of cards.
“Our advice for those people is you get a secured credit card, spend a little bit every month and pay in full. Very quickly you see your credit improving and you see these options, which can save you hundreds of dollars,” he says.
A credit card is the only vehicle that allows someone to build a credit history without being in debt, Papadimitriou says. Credit scores are used in determining mortgage interest rates, insurance costs and even when applying for a job or apartment.
However, maxing out your cards can hurt your credit score, another potential trap, Emmel says.
One component of a credit score is utilization rate, or how much of your total available credit is already used. Emmel says it’s important not to use more than 30 percent of your available credit.
So, if someone has four credit cards with a limit of $2,500 each, they wouldn’t want to carry a balance of more than $3,000 total.
Years ago, financial counselors told clients to close accounts once they’re paid off, Emmel says. Now the advice is to just stop using them, which takes more discipline.
“Credit cards can be used effectively, they can be helpful, they can be convenient,” Emmel says. “You have to be wise, use them wisely. If you can’t use them wisely, in the long run they can cause more damage to your credit score.”
On the Web: