Many people think of credit cards as a means to earn rewards or an easy way to finance purchases, but they’re actually a lot more than that. Credit cards can be a valuable financial tool for folks who want to build credit, and using one the right way can make life easier and less stressful.
If you have a credit card already or you’re thinking of getting one, there are myriad ways to use your card as the powerful financial tool it is. But there are just as many ways to get into trouble with credit, too. Avoid all these common credit card pitfalls and you’ll be in good shape.
The advantages and disadvantages of credit cards
Most people know that credit cards build credit history through on time payments, which are directly used to determine your credit score. This can be good or bad, depending on your credit habits.
For example, making late payments and racking up too much debt can negatively impact your credit score, whereas doing the opposite (making on time payments and avoiding debt) can help push your credit score to greater heights.
Using a credit card for purchases and paying off the balance in full each month will let you build credit and earn rewards, but carrying a balance each month can become incredibly costly. If you carry a monthly balance, it’ll accrue interest according to the card’s annual percentage rate, or APR. The current average APR is over 20%, meaning your interest charges would quickly wipe away any value you’d get from the card’s rewards.
Now that you have some background, here are the main advantages and disadvantages of credit cards.
Advantages of credit cards
- Build credit for the future: Credit card companies report credit usage to the three credit bureaus: Experian, Equifax and TransUnion. This helps you build credit over time and get better terms for your credit products.
- Earn rewards for spending: Many credit cards offer cash back or flexible rewards points for each dollar spent, as well as lucrative welcome offers.
- Access consumer protections: Most credit cards come with $0 fraud liability in the case of unauthorized charges on your account. Many cards also offer benefits like purchase protection and extended warranties.
- Score extra perks: Some of the best travel credit cards come with benefits like annual travel credits, automatic elite status and airport lounge access, to name a few.
- Have credit for emergencies: Having a credit card can be useful if you face a financial emergency and you need access to funding right away.
- Consolidate debt: Some credit cards offer an introductory 0% APR on purchases, balance transfers or both for a limited time.
- Convenience: Using a credit card is much more convenient than cash, and that’s true whether you’re shopping in person or online.
Disadvantages of credit cards
- Potential for long-term debt: Credit cards can make it too easy to spend, which is why many long-term users wind up with credit card debt.
- High interest rates: Credit card interest rates are higher than other types of borrowing, which makes carrying a balance very costly over time.
- Annual fees can add up: Credit card annual fees can be expensive and offset the rewards you earn.
- Fine print: Credit cards always come with their share of fine print, especially when it comes to their rewards programs and intro APR offers, meaning it can take some extra work to learn the ins and outs of your card.
Choosing the right credit card
Part of using a credit card as a financial tool involves having the right credit card to begin with.
Consider your spending habits
Take a look at your past spending to see which categories you spend the most in and how much in purchases you normally charge within a month.
This can help you find a rewards credit card that offers more points or cash back in categories you normally spend in, and one with a welcome bonus you can easily earn through regular purchases and bills.
Understand the rewards program
Figure out which type of rewards you want to earn, whether that’s cash back, flexible travel rewards, airline miles or hotel points. Take the time to understand how you can use the different reward types, as well as their limitations.
Compare interest rates and fees
Look for cards with no annual fee or an annual fee that fits into your budget. Consider the benefits you get and how often you can take advantage of them. Also, look at a credit card’s regular variable interest rates, and carefully read over any intro APR terms that apply.
Review the card perks
Finally, check credit card offers to see which ones offer the benefits you want. These could include purchase protection, extended warranties, travel perks, travel insurance or intro APR offers.
Strategies to best use your credit card as a financial tool
Once you find the right credit card for your needs, you’ll want to use it with purpose. For the most part, this means using your card to improve your financial situation while avoiding the most common credit card blunders.
Building your credit score
The two most important factors that make up FICO scores are how often you pay bills on time (payment history) and how much debt you owe in relation to your credit limits (credit utilization). These factors make up 35 percent and 30 percent of your FICO score, respectively. Always pay your bill on time and keep your credit utilization low for the best results.
Paying every bill you have early or setting up autopay could go a long way to making sure you never miss a credit card payment. Most experts also recommend keeping your credit utilization below 30 percent of your available credit to have the best impact on your credit score.
Utilizing rewards
Put your rewards to work in whatever way would benefit you the most, whether that’s redeeming airline miles for airfare or using cash back as statement credits to reduce the amount of your credit card bill each month.
Most importantly, use your credit card rewards to your advantage instead of letting points linger in your account for years on end.
Tracking your spending
Credit cards make it easy to know exactly where your money is going and how much you’ve spent. Use your monthly credit card statements and mobile apps as a tool to help you track your spending throughout the month. It could help you uncover spending patterns you’ll want to change.
Using a balance transfer or introductory purchase APR
Some credit cards offer introductory 0% APR for a limited time. You can use these cards to consolidate and pay down other high-interest debts, or to make a large, planned purchase you want to finance over time.
In either scenario, you’ll want to have a plan to pay down your full balance before the intro offer ends. Otherwise, it’ll start to accrue interest at the card’s variable rate.
Mistakes to avoid when using credit cards as financial tools
Credit cards are convenient, but that can also lead to trouble. Fortunately, you can avoid most issues if you use credit intentionally and with a plan in mind. Avoid these mistakes:
- Charging unplanned purchases: Credit cards are best used alongside a monthly spending plan that accounts for paying off the balance each month or right after you make a purchase. If you make purchases you don’t have the money to cover, credit card interest can eat into your savings.
- Paying the minimum: Paying only the minimum amount on a credit card can keep you in what feels like endless debt, especially if you’re continuing to use the card for new purchases.
- Paying late: Late payments can cause considerable damage to your credit score, and late fees and penalty interest rates can apply.
- Carrying too much debt: If you have a high credit utilization ratio, this tells lenders you may be strapped for cash. It could lead to higher interest rates and a lower credit score.
The bottom line
For the most part, credit cards are a powerful financial tool, one that should be used carefully. Consider setting long-term credit goals. This could include building a budget, using your credit card like a debit card to avoid interest charges, and profiting from rewards without going into debt. Think about turning on automatic payments to ensure you never miss a due date and your credit score only goes up.
If you feel you won’t be able to do what it takes to benefit from credit cards, you may want to stick to cash and avoid them altogether.
FAQs
Paying your credit card bill on time and keeping credit utilization below 30% of your available credit will help your credit score the most. Also refrain from opening too many new credit card accounts over a short time span, and avoid closing old accounts you’re not using, since these can lengthen your average credit history and lower your credit utilization.
Avoid credit card debt by planning your purchases and paying them off right away.
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