Credit card, friend or foe

Back in February, I wrote about the finance class we took. I have intended since then to add my own thoughts to the class outline that I presented. Specifically, I have been thinking about credit cards.

I see articles in the news on a regular basis about families whose credit card debt has spiraled out of control. The credit card companies consistently make the news for their bad behavior.

Dave Ramsey, the author of the class we took, is very adamant that there is no positive side to credit card use. He suggests using a cash envelope system for items such as groceries. If a card is needed for travel or Internet purchases, he suggests using a debit card.

My first rule about credit cards: Credit cards aren't for credit. If you don't have the money in your possession to pay for a purchase, don't make the purchase. Even if it has never caught up with you, it isn't worth the risk (or the anxiety!) You should have cash on hand to cover last month's credit bill and current month's expenses. Essentially, you could convert to the cash system on a moment's notice if you wanted to--pay off your bill and put your cash in your envelopes. My second rule about credit cards: Always, always, always pay your bill on time and in full. If you don't, your credit score will suffer and you will be hit with fees. Not paying your bill on time and in full is the first step (or giant leap) down the slippery slope of credit card debt.

I would not be giving a full picture of credit cards if I didn't list the positive aspects, as well.

1. Credit cards offer consumer protections. When you make a purchase, you normally have 60 days to dispute the charge if the seller fails to fulfill his end of the deal. I've made use of this feature before with success. Also, if there is unauthorized activity on your account, you simply notify the credit card company within the 60 days. If your card is stolen, you simply call the credit card company. They reverse the unauthorized charges and issue a new card. The thief never gets his/her hands on your actual money.

2. Credit cards are convenient. This is a double-edge sword, but you don't have to keep large amounts of cash with you or worry about keeping track of your checkbook. (Many people use debit cards as a substitute for credit cards. There are some definite things to watch out for when you do this. I hope to discuss this in a future post.)

3. Credit cards offer rewards. My personal preference is to skip any card with an annual fee, and to pick a reward card that has easy-to-redeem rewards. We use a simple cash back card. Whatever reward you choose, make sure you redeem it!

4. Good use of credit cards is important for keeping your credit score high. This benefit of credit cards is second in importance only to the protection from theft. Using your credit card regularly and paying your balance on time and in full does two things. First, it creates a payment history. Payment history is 35% of your credit score. On-time payments boost your score. Second, it creates a credit history. The length of your credit history is 15% of your score. The longer you have been using credit, the higher your score will be. Another 30% of your score is based on the amounts you owe and your available credit. Your score will be the highest in this category if you use only a small amount of your available credit. From what I have read, aim to use no more than 10-20% of your available credit. Even for those who have decided to no longer use credit, my recommendation is to consider keeping those accounts open and charging at least a nominal amount every month. There is an explanation of what's in your FICO score on the My FICO website in the education section.

Like it or not, part of keeping a high credit score is playing the game. You might be thinking, "Why do I need a high credit score?" The most obvious reason is to get the lowest interest rates. Most people (at least most people my age), even if they don't have other debt, still have a mortgage. If you move or refinance, your credit score is what determines your mortgage rate. For reasons that aren't always clear, credit scores are also used by employers when deciding on job applicants, landlords when deciding on tenants and rent amounts, and (this one makes the least sense to me) by insurance companies to determine rates. Many insurance companies now are using credit scores instead of driving history to determine car insurance rates! It may not make sense, but it is a fact. It hits us in the pocketbook in more ways than one if we don't have good credit, and part of having good credit is to have credit, and to use it responsibly.

So, credit card, friend or foe? In my opinion, neither. A credit card is a tool, one that is part of your whole financial picture. Credit cards can be used wisely or unwisely. What things have you learned about credit cards?