There are about $800 billion in credit card debt in the United States of America. On average, household with credit cards owe a total of more than $15,000 (P630,000) on five cards, including retail cards.
Credit cards can indeed be a great convenience and can, if used properly, even save you money. But, as all too many people have discovered, these little pieces of plastic have a lot of potential for misuse and misery. When you make a credit card purchase, the merchant contacts the credit card company, through electronic card readers, to verify that the card is valid and the amount of the purchase is validated. If the charge is accepted, the amount of the purchase, less a transaction service fee, is credited to the merchant’s account and the full amount is debited from your card account. The merchant fees, ranging from less than 1% to 5%, are one of the ways the credit card companies make their money.
In contrast, a debit card is connected directly to your bank account, either checking or savings. When the cashier swipes the card, the amount of the purchase is deducted immediately from your account. Debit cards have a couple of advantages over credit cards. One is that you cannot overdraw your account because you cannot spend the money you do not have when using a debit card. Another advantage is that anyone can get a debit card. Since there is no borrowing of money involved, a debit card is risk-free to the institution that provides it to customers. There are also some disadvantages to debit cards when compared to credit cards. An important one is that with a debit card you are always using your own money, while a credit card gives you free, temporary use of the bank’s money. Many credit cards offer premiums, such as airline miles or cash back, and debit cards do not.
Every credit card has an interest rate, and in fact, most have more than one. A typical account might have the following:
- One interest rate, relatively low, for balance transfers
- A higher rate for your purchases
- A third, still higher, rate for cash advances.
Some credit cards charge an annual fee. Other fees are present on all or most cards but by using your credit card properly you can always avoid them. These include: (1) late payment fee (2) over limit fee if the account balance goes over your credit limit (3) inactivity fee that is charge if your account is idle for too long.
Aside from convenience, credit cards have other advantages that some people might not be aware:
- On line shopping – it is essentially impossible to shop online without a credit card.
- Fraud protection – if someone gets hold of your credit card number and steals your card, they might run up of thousands of pesos in charges. But with limitation and you are liable for the first hundreds of pesos of such charges. With a debit card, a smart thief can empty your account and you are out the entire sum.
- Transaction protection – suppose you order something online and you receive the wrong or defective item. If the merchant will not fix the problem, you can turn to your credit card company and contest the charge.
- Free insurance and airline miles.
Many credit card companies are offering reward cards that give you something back based on how much you use the card, such as airline frequent flier miles, credit toward purchases at a particular store, or cash rebates, perhaps .5% to 1% or more of purchases. Reward cards are most effective if you charge a lot on your card. But do not charge a lot trying to pile up the rewards unless you can pay your balance in full each month. The interest you pay on a balance carried over will cancel out any rewards you get, many times over.
The most common way people get into trouble with credit cards is by carrying a balance from statement to statement – in effect using the card as a source of a long-term loan. Interest will be charge on you. Suppose you carry a P5,000 balance on your cards. You charge new items each month and also make a payment, but on average your balance is this amount. If you are paying 10% interest – relatively low by credit card standards – you are wasting P500 a year on interest. You have things you could do with that P500 that are a lot important and more enjoyable than making the credit company rich, by investing this amount.
One of the things you might want to do with a credit card is get a cash advance – in effect a loan against your account. There is no doubt that the ability to quickly get some cash can be very useful. You can take your credit card to essentially any bank or ATM and get cash you need right then and there. However, it can be expensive. First, there is no grace period as there is with purchases – the interest charges start accumulating the moment you take the advance. In addition, there is almost always a flat rate that is typically 3% of the amount of the advance.
Used wisely, credit card can be an important part of your healthy financial situation. Used unwisely, they are a sure road to debt and lost control of your finances. The following are tips for credit card wisdom:
- Never charge you cannot pay off.
You should not charge anything you cannot pay for when the bill comes. Ask yourself, “Do I have enough cash to pay for this when the credit card bill comes?” The evil side of credit cards comes out when you start carrying a balance from month to month and paying those nasty interest charges. If you always pay your balance in full each month, you will never have this problem. What about emergencies, such as car repairs, or a visit to the dentist. In this case, you may attempt to time your purchase to coincide with as much float as possible (see grace period)
- Use the grace period.
The grace period is a very important feature of credit cards and makes them a valuable tool for the savvy spender. If you pay your balance in full, on time, you incur no interest charges or other fees. This means you have the use of the bank’s money, free, for the period between when you make the purchase and when you pay your balance. This period range from a couple of weeks to well over a month, depending on how the purchase date relates to the closing and payment due date. However, the grace period applies only to purchases and not to cash advance or balance transfers.
- Be careful to make payments on time.
This is important because it you are late for just a day, an interest will be charge to your account, aside from the regular interest on your purchases.
- Mind your credit limit.
You should be mindful of the credit limit on your card and be sure never to exceed it to avoid the resulting fees. Even if you pay your balance in full each month, your charges since the last payment might be pushing up against that limit.
When you buy a digital camera or a widescreen TV with a credit card, you should know its real cost. If you carry a balance in your credit card account – that item is going to cost you more that what it says on the price tag. So beware!
The most advisable is to pay off your balance in full, if you have the money to pay off your credit card. But if you have no money, there are still some approaches to paying off, or at least paying down your balance. Some of which are:
- Money from your emergency fund.
- Savings and investment money. Initially you would not dare to touch it, but by paying off your balance is a much better investment. Take a look. It is really silly to have P5,000 in mutual fund earning maybe 8% while at the same time paying 20% interest on a P5,000 credit card balance.
- Consider borrowing at a lower rate than you are paying on the cards.
- Look for another card with lower rates. Beware of balance transfers interest.
Kiplinger’s Personal Finace, April 12, 2012
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