How to use credit cards wisely: A definitive guide
It's back to basics month at Get Rich Slowly! Today, we're going to take a l-o-n-g look at how to use credit cards wisely. Believe it or not, credit cards can be a useful tool — so long as you don't fall into debt.
For a long time, I thought credit cards were evil. Starting in college, I abused credit cards. As a result, I ended up deep in debt. Those two decades of debt sucked, and they led me to believe that credit cards were dangerous.
Well, credit cards are dangerous — but they're not evil. Credit cards are a tool. Like any other tool, credit cards can be used to build or to destroy. Just as you'd treat a chainsaw with respect, you need to be careful with credit to avoid hurting yourself. If you use credit cards wisely, they can actually give you a financial edge!
Because this is a long article, I've create a table of contents so that you can jump to the section you need. (Or, you can read the entire thing, of course.)
Table of Contents
How Credit Cards Work
First, let's review some basics.
When you buy something with a credit card, you're taking a small loan from the card issuer — Bank of America, Capital One, your local credit union — and you owe the issuer that amount. If you pay your balance in full each month, the card basically gives you a short-term, interest-free loan. You're taking advantage of “float”.
This free float is a fine thing — so long as you pay your balance every month. But if you carry a balance, the advantage of float vanishes. Anything you might have gaines is lost to fees and high interest rates.
How many Americans carry balances and how much debt does the average cardholder owe? There's a lot of conflicting data out there, but one reliable source of information is the Federal Reserve, which every three years publishes its Survey of Consumer Finances. The latest study, from 2016, found that:
- 43.9% of American families have credit card debt, and
- the average amount owed is $5700.
Clearly, lots of Americans continue to struggle to use credit cards wisely.
That said, not everybody who uses credit cards goes into debt. In fact, the Survey of Consumer Finances shows that over half of Americans use credit cards without going into debt. They treat them as a convenience.
True story: Last year, I went into a bank to apply for a new travel credit card. During the half-hour process, I chatted with the banker. “We banks don't like people like you,” he told me. “I'm sure you're a nice guy, but you pay your bill every month. We don't make any money on you. Fortunately, 90% of people who use credit cards suck with money!” He told me banks are willing to lose money on the handful of folks who use credit cards wisely because they make so much money on the people who abuse them.
Why Use a Credit Card?
If credit cards are so dangerous, why use them? Let's be clear on one thing: If you worry about self-discipline, if there's even the slightest possibility that using credit cards might lead you to debt, the smart choice is not to use them. Outsmart yourself by not letting yourself be tempted.
That said, here are reasons people use credit cards:
- Convenience. It's easier to carry around a single piece of plastic than to deal with cash and checks. Plus, a lot of people like the automatic record-keeping that comes from using a card.
- Protection. Most credit cards offer a variety of features that protect your purchases. Some extend manufacturers' warranties. Others offer insurance for things like rental cars. Others protect you in the case of a purchase gone sour. On top of that, if your wallet is stolen, your cash is gone. But the Fair Credit Billing Act limits your liability on a stolen credit card to $50.
- Building credit. Your credit score has a huge impact on your personal finances. Using credit cards wisely improves your credit score so that you can get the best rates on auto loans, mortgages, and other financial products — including, of course, other credit cards.
- Rewards. Nowadays, most credit cards offer perks of some sorts. Some offer airmiles. Others offer cash-back bonuses. The new travel credit card I picked up last year includes all sorts of benefits, including TSA pre-check and access to airport lounges.
Again, these benefits are meaningless if you don't use credit cards wisely. If you miss a payment or carry a balance, you've negated your cash-back bonus for months (or years) to come — and you've hurt your credit score. Pay your balance in full each month, and credit cards can be a valuable addition to your money toolbox.
Essential Credit Card Skills
Okay, you get it. Credit cards are the chainsaws of personal finance. Used wisely, they can be an awesome tool. Used carelessly, you're likely to cut off a (metaphorical) arm. Let's turn our attention now to some essential credit card skills.
First and foremost: In order to use a credit card without getting burned, you can't let it change your spending habits. A credit card isn't a license to spend; it's just a different way to pay. If you're using credit cards to spend more than you earn, you're using them wrong.
Here are what I consider five essential skills to using credit cards wisely:
- Learn to read the fine print. Read the legal stuff when you fill out the application, when you receive the card, and on any future mailings. Credit card terms and conditions can be confusing. This credit card glossary from Wells Fargo can help. If you don't understand something, ask for help.
- Similarly, review your statement every month. Due dates, fees, and interest rates are subject to change. Reconcile transactions and keep an eye out for fraud. Many people — and I'm one of them — actually check their statements online several times a month. By paying attention, you can prevent small annoyances from becoming large hassles. (Just yesterday, I found an a billing error. I was charged for two episodes of Smallville on iTunes. It's only $1.98, but it's not $1.98 that I spent, so I disputed it.)
- As always, don't be afraid to speak up. If you notice something strange on your bill, call customer service. If you want to dispute a charge, call customer service. If you want a rate reduction, call customer service. It never hurts to ask.
- Be wary of the special offers your credit card company sends you. Understand the teaser rates. Beware offers to skip a payment. Be suspicious of other products the company tries to push: insurance, fraud protection, etc. Many of these are bad deals for consumers.
- Finally, pay your bill on time and in full every month. If you are not yet in credit card debt, don't start. Don't rely on credit cards to support a lifestyle you cannot afford. Don't resort to using a credit card because you can't afford to pay cash for something — use a credit card because you can.
These skills are all rather academic. They're important, yes, but they don't address the behavioral issues that lead to credit card debt. It's one thing to say “pay your bill on time and in full every month”, but it's another thing to actually do it. What most people need are real-life methods for using credit cards without going into debt. Let me show you the four laws I use to guide my credit card use.
How to Use Credit Cards Wisely
I can't speak for everyone, but I know that for me, I had to adopt an actual set of written guidelines to define what acceptable credit card behavior would look like. No joke. Because I'd been in credit card debt for twenty years, when I decided to re-enter the world of credit cards in 2007, I was very nervous. I set the following ground rules:
- I resolved to make my decision to buy first, and then decide how to pay. This may seem like common sense, but it used to be that I'd let the fact that I could pay on credit influence my decision: “I have a credit card, so I can just charge it and pay later.” Now, however, I decide whether or not to make a purchase, and then I decide which payment method makes the most sense for me: cash, credit, debit, check, etc. (I do this because research shows folks tend to spend more with credit than with cash. I'm sure that I'm not completely negating this effect, but by putting the buying decision before the payment decision, I'm hoping to mitigate the overuse of credit.)
- I vowed never to buy anything unless I had cash in the bank for it. In other words, if I see a new videogame system that I want, I won't buy it on credit if doing so means that I have to wait for cash to come in. Or, if I decide to take a safari to South Africa, I don't make the purchase unless I already have cash in the bank to cover the entire expense. I only use credit if I could actually pay with cash. (Why not pay cash then? Because often credit is more convenient, and because by paying with credit I get 1% cash back.)
- I promised to pay my card in full every month. This goes back to the last item in the list above: I never carry a balance. This is my number-one rule. Everything else is secondary. When I decided to try using credit cards again with rewards cards, I promised that if I ever carried a balance, I'd cancel the card. It's been over ten years now, and I've never carried a balance.
- I told myself that I'd never use my card for an impulse purchase. One of the things that got me in trouble with credit during the 1990s was impulse spending. And while I still struggle from a compulsion to spend, by not using credit I limit myself to the cash I have in my pocket. (I try not to use my debit card for impulse spending, either.)
Despite these careful steps, I do sometimes worry about my use of credit. Research shows that people tend to spend more with credit than with cash. Am I doing that? Is my use of credit hurting local businesses? (I won't use credit at the local bookstore, for example, because I've talked with the owner and we know that merchant fees for card use hurt her business. I always pay cash when I buy from her.) And by using credit, am I feeding the monster of predatory lending?
How to Choose a Credit Card
No two credit cards are the same. Each has its own advantages and disadvantages. Over the past decade, I've come to believe that choosing a credit card is a little like choosing a mate. That probably sounds silly, but I'm not joking.
Instead of just marrying the first person you meet, you take your time to find a partner that makes your life better. You should do the same when looking for credit cards. Decide what features are important to you, then spend time looking until you find the card that's best for you.
The biggest factor to consider is whether or not you currently carry a balance on your cards. If you do, or you're worried that you might in the future, then look for cards with low interest rates. On the other hand, if you pay your balance in full each month as you should, then your credit card interest rate doesn't matter. Instead, look for a card with no annual fee and/or a solid rewards program. (My latest card actually has a ginormous annual fee — $300! — but it also comes with a $300 “travel credit”, which effectively negates that annual charge.)
In either case, keep the following in mind as you look for the perfect card:
- Take time to do research. Your goal is to find the card that best suits your needs, so don't just sign up for the first offer that comes in the mail. You can research cards at sites like Consumer Reports, Card Ratings, Index Credit Cards, and NerdWallet.
- Check with your credit union. If you belong to a credit union, you may be able to get a great deal on a card. A 2009 study from Pew Charitable Trusts found that “credit unions offered significantly lower advertised rates compared to bank credit cards, with penalty fees that were half the cost of comparable bank fees and fewer dangers associated with ‘unfair or deceptive' practices.”
- If you're after a rewards card, choose one that offers something you value. Some offer frequent-flyer miles or other “points”. If these appeal to you, great. But if you're not a big traveler, consider a cash-back card. Cash is versatile and, unlike airmiles, never expires.
- Watch out for extra fees. Some fancy cards carry great perks — at a price. You're usually better off with a no-fee card than paying $50 or $100 (or more) for features you rarely use.
- Look for more than just a low interest rate. Though it might sound like gibberish, a credit card's method of computing the balance for purchases is important. Look for cards that calculate your interest using either “average daily balance” or “adjusted balance”.
Once you've chosen a credit card, be sure you understand its limitations. Always read the fine print before you sign up. Remember: Your goal is to pick a useful tool. You're not looking for a one-night stand, but a long-term relationship you can live with.
Which credit cards do I use? In 2007, at the prompting of Get Rich Slowly readers, I signed up for the Capital One No-Hassle Cash Back card, which not only gave me one percent cash-back on every purchase, but also came with some nifty travel benefits. For a decade, that was my main personal credit card. (In 2011, I signed up for a British Airways card from Chase, but that was just to get the miles. I don't use it.)
Last January, “>I switched from my Capital One card to the Chase Sapphire Reserve because the latter boasts tons of travel perks, which I use often. So, there you go: I have three personal credit cards — although I only actively use one of them.
How to Dispute Credit Card Charges
Mistakes happen. Once in a while, a restaurant will charge you twice for the same meal. Or they'll charge you for somebody else's dinner. Just last month, my girlfriend noticed that the gym membership she'd cancelled two months earlier was still being charged to her account.
When you notice something goofy on your credit card statement, it's important to act quickly to correct the problem. Here's how:
- Gather documentation. To make things easier when trying to resolve the issue, take time to gather supporting info such as receipts, warranties, and written contracts.
- Start at the source. Before contacting your credit card issuer, first contact the merchant that charged the card. Explain the problem and ask them to resolve it. If that doesn't worth, then move to the next step.
- File a dispute with your card issuer. As soon as possible, send a written complaint to the issuer's “billing inquiries” address (not the address where you send payments). Include info about your account, an explanation of the problem, and copies of any supporting documentation. The FTC offers a detailed description of the process. Also, most card issuers now have an online dispute-resolution process, which may be more convenient than filing a dispute by mail.
- Take your complaint elsewhere. If you're unhappy with how things turn out, contact agencies such as your state's Attorney General's office or the local Better Business Bureau.
Note that these steps are for disputing improper charges, not for fighting over shoddy merchandise. Your credit card may offer some protection if your new computer is a lemon, but you'll need to read your card agreement to know your rights. Save the dispute process for actual billing errors.
How to Cancel a Credit Card
If you have trouble with compulsive spending, it's best to take away the tool that makes it so easy to get into trouble. Don't just cut up your credit cards — cancel them. Doing so buys you time to learn to manage credit responsibly without a constant temptation to spend. Even if you don't have trouble with credit, you may still want to close an account from time to time.
Canceling a credit card is easy. But if you're going to do it, do it right.
- Close just one account at a time, even if you're closing several. First, cancel cards that charge you fees. Also, it's better to cancel new cards before old ones. And you may want to keep cards with good rewards programs.
- Before you close an account, pay off your balance or transfer it elsewhere. If you try to cancel a card while it still has a balance on it, you might end up paying nasty fees and high interest rates.
- Contact your credit card company. You can cancel some accounts online, which is convenient because often when you try to cancel by phone, the sales rep will do his best to talk you into staying. If this happens, be firm.
- Send written confirmation. Follow up by writing a letter like this one to the card issuer.
- Watch your credit report. It may take several weeks for changes to appear on your credit report. It's your responsibility to be sure the report is accurate, so keep tabs on it. You may also want to watch your credit score to see if canceling the card did any damage.
- When you're certain the account is closed, cut up your card.
Be aware that canceling a credit card may actually hurt your credit score. Part of your score is based on how much of your available credit you actually use; this is your credit utilization ratio. When you close a card, this ratio jumps because you're using more of your valuable credit. And when this ratio jumps, your credit score goes down. (Also note that the longer you've had an account, the more you'll affect your credit score by closing it.)
If you think it's important to keep a high credit score and you're sure you won't abuse them, then keep the accounts open. But it's a mistake to keep your credit cards if having them will tempt you deeper into debt.
The credit card industry earned $163 billion through fees and interest in 2016. Much of this profit comes because they've made it easy for folks to spend more than they should and because people don't understand the rules of the game. Remember: Your credit card company is not your friend. They're hoping you screw up because that's how they make money! In fact, the industry's term for somebody who pays their bills on time is “deadbeat”. Nice, huh?
But millions of people — more than half of credit card users in the United States — have found that if they play by the rules, credit cards can make their lives a little easier. (Some brave folks even try to beat the credit card companies at their own game!)
Your credit cards will never make you ruch, but used wisely they can fee you to focus on the things that matter most in your life — and earn a few rewards in the process.