I grew up in a lower to middle-class family, was raised to never talk/ask about money, and was never taught how to balance a checkbook. The one thing I was taught about finances though was the evils of credit cards and to never, under any circumstances, sign up for one. If you were also raised to fear credit cards like the plague – this one’s for you.
While I agree that credit cards can be extremely dangerous, they can also be wildly beneficial when managed properly, especially early on in your financial and credit journey. Similar to the annoyance of trying to get a job in a new industry and being told you have to have experience to get the job – typically you have to have credit to get credit.
During my time in lending, I found that sometimes it’s better to have mediocre or bad credit than no credit at all. When a lender is reviewing your creditworthiness and deciding whether to take a risk on you, having no history gives them no insight into your ability and willingness to pay back a loan. Enter credit cards – using a credit card can be a very simple way to build credit and begin developing a history to show your reliability to lenders. By no stretch does this mean to get a credit card and max it out. Instead, pick a monthly expense like gas, a utility bill, or a phone bill – pay it using your credit card every month but also – and this is key – save the same amount of money as you’re putting on your card and then pay it off. As you do this month over month, your credit report will reflect on-time payments and will also show any balances you are carrying (or not carrying) month over month.
Why it Matters
Managed properly, this starts to build your (positive) credit story and shows lenders something they can bet on when it’s time for a bigger loan like an auto or home loan. In the past, I saw many customers who saved for the full cost of their first car and paid cash or who have been saving a long time for a significant down payment on their home only to be denied for a new auto loan or a home loan because they never put anything on credit and have no history to show. In those situations, time and again, I was told that they were raised to never get a credit card. While it’s a great feat to save for what you need and avoid debt, in a world that runs on credit – you don’t want to be caught credit-less when you really need it.
The myth – credit cards are the root of all evil and no one should have them. The myth debunked – credit cards are a great way to build credit and kick off your credit journey when used responsibly.
Credit Card Tips
A tip if you can’t get approved for a credit card or want a low-risk option to jumpstart your or your kids’ credit as they head into college – seek out a secured credit card. A secured credit card is a credit card in which you provide collateral so that there is no risk for your lender. Usually, these cards have a small limit like $300-$500 which you will fund. You are still responsible for paying the credit card as normal, but the benefit to the lender is that if you don’t pay it, they will use the funds you put down to pay it off if needed. A secured credit card still shows on your credit report and shows your payment history. Once your lender sees that you are making consistent payments, they will be more open to swapping out your secured card for a regular credit card or a different loan as needed.
Look for a credit card that has a low interest rate. While you can usually get a credit card at your favorite department store with a great first purchase deal, they typically come with steep rates and high penalties. Pay attention to cards with offers for 0% interest for a given amount of time. While these can be beneficial, often the fine print includes details that state if you don’t have the introductory balance paid before the given amount of time, they will add the total interest accrued to your balance. Store cards aren’t the only cards to look out for, even when using tools like Credit Karma, you are often faced with a higher rate than necessary, even with a great credit score. The alternative – shop around at your local credit unions to determine who is offering the lower rate. Credit union interest rates, fees, and penalties are often lower than other lenders.
Only Spend What You Can Pay Off
Even with a lower-rate credit card, if you max out your card and can’t pay it off immediately, it gets tougher and tougher to pay off because you are hit month after month with interest until you get it back down to $0. Additionally, to make credit even more fun, when you have revolving credit like credit cards, it can hurt your credit if you are using more than a given percentage of your credit line. You may see your credit fluctuate as you go from lower to higher to lower usage percentages.
Part of a credit score also depends on the length of time your credit cards are open. Rather than closing out a card you don’t want anymore or closing one out you have paid off, cut up your card if needed, but don’t close out that credit line. Instead, let it build maturity on your credit report.
While maxing out your credit card may be the quickest/easiest option during an emergency, there may be better options if you have time for research and have built up some credit. If you can shop around for a low-rate personal loan, this will often have a lower interest rate than a credit card. Have a car that is paid off or that has a loan but has some equity? Great! Using the equity in your car for a loan is sometimes the best way to get the lowest rate for the money you need in a pinch. If you have the time, weigh your options, and determine which option will set you up for success.
I hope this has helped you see credit cards a bit differently and dispel some of the fears instilled in us. Talk to your lenders about what credit/loan option will work best for your needs and keep asking questions.