A 3-inch-by-2-inch piece of plastic holds the power to simplify your financial life — or ruin it.
Whether a credit card turns out to be friend or foe depends on how you use it, says Beverly Harzog, a credit expert and author of “The Debt Escape Plan.” “Credit cards are not evil,” she says. “They really are a great tool because they can help you build great credit.”
On the other hand, the temptation to overspend increases when you have a credit card rather than a debit card. Currently, Americans carry more than $1 trillion in revolving debt such as credit cards, according to the Federal Reserve.
“Not everyone should be using credit cards, and it’s important to be honest with yourself,” Harzog says. “That’s not a weakness. That’s just facing facts.”
Here are some of the ways in which credit cards can help stabilize your finances — and the hidden dangers that sometimes make such cards toxic to your financial health.
The Pros of Using Credit Cards
Credit cards offer many benefits that can make them the most attractive way to pay for goods and services.
Credit cards help you build a credit history. Using a credit card instead of a debit card and making payments on time helps you establish a solid credit history and a strong credit score.
[Read: The Best Starter Cards for Building Your Credit.]
“When you have a great score, you’re going to save money down the line,” Harzog says. She notes that top credit scores help you get the best mortgage and loan interest rates and the best price for auto insurance.
To build up a great score, use your card sensibly. The amount of debt you carry makes up 30 percent of your FICO score, the credit score most lenders look to first. Paying your bill on time accounts for another 35 percent of your FICO score. It is important to keep these factors in mind when using credit cards.
“It’s imperative that they are used responsibly, or else it’s going to backfire,” Harzog says.
If you struggle to make payments — or if you simply run up large balances on your credit card each month — it might make sense to pay with cash or checks a bit more often.
Credit cards offer convenience and quick access to cash. A credit card gives you instant access to major purchasing power. “It’s a good thing to have for emergencies,” Harzog says.
Harzog says she keeps a credit card with a low interest rate handy for such situations. That strategy paid off when she suddenly needed a new roof but did not have the cash to pay for it upfront.
“Maybe you can pay that off in two months, but you can’t with the cash flow of one month,” she says. In such situations, a credit card makes sense. However, if you know you will not be able to pay off the bill for months or years — or, if all your credit cards have high interest rates — you might consider another option to pay the bill, such as a personal loan, Harzog says.
Credit cards offer key protections. A credit card gives you far greater safety than cash or a debit card when you shop, says credit expert John Ulzheimer, who has worked for both FICO and the credit reporting agency Equifax in the past. “It’s infinitely safer,” he says. “It’s almost not even on the same chart as using cash or a debit card.”
If somebody steals your credit card and starts ringing up purchases, federal law limits your liability to $50, and many cards offer zero liability protection. By contrast, lost or stolen cash is never found again. “If you lose cash, it’s gone,” Ulzheimer says. “There’s nowhere you can go to get it back.”
In addition, debit card protections are not as robust as those of credit cards. Fail to report unauthorized charges on your debit card within two business days after you learn of the fraud, and you could be on the hook for $500 of your losses. After 60 calendar days, you could be responsible for the entire loss.
Also, someone who gains access to your debit card can begin pulling money straight out of your checking account. “If someone abuses your debit card, then that’s your money that’s being abused, not the bank’s money,” Ulzheimer says. Until that money is restored to your account, you might have trouble paying bills and meeting other financial obligations.
Credit cards offer rewards. Points, cash back and other rewards are among the best reasons to use a credit card for purchases. Ulzheimer says he uses credit cards as often as possible so he can rack up rewards.
[Read: The Best Rewards Credit Cards of 2018.]
“They essentially equal a discount of the purchase price of the item that I am buying because I am getting something back from my card issuer,” Ulzheimer says.
Harzog also is a fan of rewards programs. “I think that’s one of the best benefits, but you have to use your card responsibly,” she says. That means paying off the balance in full every month. Otherwise, interest charges over time can easily swamp any rewards benefits you might earn.
The Cons of Using Credit Cards
As with most financial tools, credit cards have a shadow side. Fail to use a credit card well, and you will pay the price. “If not used responsibly, it’s a very dangerous thing, and it can ruin your financial life for quite a while,” Harzog says.
Credit cards make it easy to pile up debt. Overspending with a credit card can send you tumbling into a deep pit of debt.
“Credit cards can be very dangerous if you’re not using them responsibly,” Harzog says. “Your finances can get out of control in a hurry.”
Many people charge just a little too much on their credit card one month, then pledge that they’ll pay it off the next month, Harzog says. Despite their good intentions, the balance keeps growing.
As the interest compounds month after month and the debt grows, financial clouds gather. Miss a minimum payment or two, and it will zap your credit score.
“You’re going to ruin your credit,” Harzog says. “You’re going to have to rebuild your credit score, and that takes time. It doesn’t happen overnight.”
Credit cards carry high interest rates. Pay for goods or services with cash or a check, and your savings will be a little less robust. But make that same payment with a credit card, and it can wound your finances for months — or even years — if you do not quickly pay off the charge.
In early March, the average credit card interest rate stood at 16.41 percent, according to CreditCards.com. So, if you only make the minimum payment on your credit card each month, your debt will compound quickly.
Ulzheimer says combining as little as $15,000 of debt with a high interest rate can cause your obligations to spiral out of control.
[Read: The Best Low-Interest Credit Cards of 2018.]
“If you get into too much credit card debt and you are only able to make those minimum payments every month, you’ll probably pay your house off before you will end up paying your credit card off,” Ulzheimer says.
Credit card purchases sometimes come with sneaky fees. Have you ever tried to pay a bill with your credit card only to learn you will have to pay a few dollars extra for the convenience of doing so?
These sneaky little costs are the result of the interchange fee that a merchant’s bank must pay every time a customer uses a credit card to pay for a good or service from that merchant. Businesses sometimes charge a “convenience fee” to the customer to recoup the cost of this interchange fee.
On a big purchase, the convenience fee can add up. For example, Ulzheimer says his son attends a private school, which allows parents to pay tuition on a credit card. “They want you to cover 4 percent of the tuition so they can cover their interchange fee,” he says. “So, from that perspective, it’s easier for me to pay using an old-fashioned check or a wire transfer from my bank.”
Credit cards make you feel richer than you are. If you only have $300 in cash — or a similar amount in a checking account — you have an enforced limit that prevents you from spending too much.
“If you’ve got a $25,000 limit on a credit card, obviously you have considerably more buying power,” Ulzheimer says. “Some people will tend to overspend simply because they have the ability to do so.”
For her part, Harzog says people should not use credit cards to inflate their lifestyle. If you cannot pay off the amount in full, take it as a sign that you need to rein in spending, Harzog says.
“I don’t recommend credit cards for anybody who can’t pay the bills that they have,” she says.
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The Pros and Cons of Credit Cards originally appeared on usnews.com
