Credit cards have a reputation—some of them are good and some of them are not-so-good. Is it important for today’s consumer to acquire a credit card or two?
The buy-now-pay-later agreement has been around for many centuries. Small town merchants all over the world allowed business owners, farmers, and townspeople to receive needed supplies without upfront payment as long as they had a good reputation. After goods had been sold, crops had been harvested, or laborers had been paid, people then had the money to repay the merchants.
This I.O.U.-type system is the idea behind today’s credit cards. People today usually need to qualify financially in order to obtain a credit card and can use them in a variety of ways. Let’s take a deeper look.
Credit Cards Versus Debit Cards
With the introduction of the modern credit card in the 1950s, people found it more convenient to charge now and pay later. Another type of card, the debit card, became popular in the 1980s. What’s the difference?
● Credit Cards. These cards give you the opportunity to borrow funds from a bank or other financial institution. The interest that you are charged on your purchases can vary from bank to bank. This line of credit usually has an annual fee and a preset spending limit. Currently, the average person has $5,934 in credit card debt.
● Debit Cards. In actuality, this card is a payment card. It is a way to pay for something directly from your personal checking account rather than paying by cash or check. Usually these cards do not have an annual fee and you don’t pay interest on your purchase because you are drawing from your own banking account.
Pros and Cons of Credit Cards
Like most things in life, there are advantages and disadvantages to having credit cards. It’s important to understand the benefits and risks to get a better idea of whether or not credit cards are a good fit for you. We will break down the common pros and cons.
There are many advantages of having a credit card, including:
● Accumulating rewards. Most credit cards have a rewards program where you can earn rewards on each dollar you spend. Points are accumulated for perks such as airline miles, cash back rewards, or discounts.
● Building credit. When you borrow money and pay it back, you are building your credit history. This history shows banks and lenders your creditworthiness and determines your overall credit score. This three-digit score affects many areas of your life including your ability to qualify to rent or buy a home, secure a job, and borrow large sums of money.
● Protecting against fraud. Paying by credit card can be more secure than paying by cash or debit card. They offer an extra layer of security against thieves, disputed charges, and lost or damaged purchases.
● Receiving extended warranties. Some credit cards include extra purchase protection and extended warranties on major purchases like household appliances.
It’s important to also look at the downside of credit cards. Some cons include:
● Impacting your credit score. When you pay your credit card statement on time and keep credit card balances low, these contribute to upping your FICO credit score. But if you habitually make late payments, use up all your available credit, and apply for too many credit cards, your credit score will plummet. This all contributes to your credit history and reveals to banks and lenders your creditworthiness or lack of it.
● Overspending. Are your eyes bigger than your wallet? For some people, having a $2,000 limit on their credit card means they will be tempted to go out and spend until they’ve reached that dollar amount, overextending themselves. For others, that limit is a security that they have money available to them if they need it. Knowing yourself and knowing whether you are a saver or spender at heart is an important benchmark.
● Paying fees and interest. All credit cards, because they are basically short-term loans, charge you interest. If you pay off your balance each month that isn’t a problem. But if you just pay the minimum payment each month, you are paying anywhere from 12 to 21 percent more for the items you purchased because of interest accrued. Now, many credit cards do not charge an annual fee, but there are those whose annual fee can range anywhere from $35 to $5,000 a year. It’s important to weigh the pros and cons of any potential rewards against the fees charged.
Almost everyone needs to borrow money or have access to credit from time to time. If you have decided that credit cards offer enough advantages to you that they are worth having, how many should you get? It depends.
Your financial situation and your current credit score will determine how many cards you can get approved for, but your ability to pay will determine how many you can actually handle. Some questions to ask yourself include:
● How much experience do I have in managing my money? If you are new to earning an income and managing money, you may want to start out with one credit card and learn over time to handle it wisely. On the other hand, if you have successfully been in charge of your finances for a while you may be able to handle having multiple credit cards.
● What is my goal in applying for this card? Perhaps you need to build credit history or increase your credit score. Maybe you would like to accumulate reward points with regular purchases on the card. Or you want to have access to funds for future expenditures.
There is no magic number of credit cards a person should have. Some people are good with one credit card while others are comfortable managing four or five. The important thing to remember is your ability to pay off any balance on the cards each month without going over your budget.
There are both advantages and disadvantages to having credit cards. Deciding whether or not to acquire credit cards can seem overwhelming, but by looking at your personal financial situation, your spending habits, and your ability to handle money, you will get a better idea if they are a good match for you. Need advice? Consulting with a financial planner can give you a better perspective.
Written by Matthew Delaney