There's a reason credit cards tend to get a bum rap. When used recklessly, they open the door to a seemingly endless spiral of debt. But if you're smart about how you use your credit card, you stand to reap a host of benefits. Not only can using a credit card help you establish a solid credit history and boost your credit score, but you'll gain access to a host of rewards that cash and debit cards simply don't offer. Here's a quick guide to responsible credit card usage -- and what it can do for you.
How credit cards work
Most people are familiar with the concept of credit cards -- you use yours to pay for the things you want or need, and then, if all goes well, you pay your balance at the end of the month and move on to your next billing cycle. And repeat.
The problem, however, is that things don't always go so smoothly. In fact, 38% of U.S. households carry some type of credit card debt. But if you follow these credit card rules, you'll avoid the trap that countless Americans have already fallen into.
Credit card rule No. 1: Always pay off your balance in full
The beauty of using a credit card is that you automatically get a grace period for paying off your purchases. Say you charge a $300 item on your card at the start of your billing cycle. If your bill comes due a month later, and you pay it off in full, you'll have essentially gotten an interest-free $300 loan for several weeks.
But what happens when you can't pay your bill in full? The moment you begin to carry a balance, you'll automatically start accruing interest charges, which will compound daily until you find a way to eliminate your debt completely. In other words, if you fail to pay off your balance in full, you'll turn what should be a financially beneficial situation into a liability that'll cost you -- which is why you should pledge to never charge more on your credit card than you can afford to pay off by month's end.
Credit card rule No. 2: Always pay on time
When used correctly, credit cards can actually help you build your credit. That's because your payment history is a major factor in determining your credit score, and if you make a point to always pay your bills on time, you'll come across as a trustworthy, responsible borrower. Being late with your payments, or skipping them altogether, can have the opposite effect -- you'll knock down your credit score so quickly you won't know what hit you. If you're going to use a credit card, it's imperative that you make your minimum payments on time, even if you can't pay off your entire balance.
Credit card rule No. 3: Stay well below your credit card limit
Contrary to popular belief, your credit card limit isn't an invitation to spend away. In fact, if you spend too much of your available credit, your score will get hurt in the process. Just like your payment history plays a big part in factoring your credit score, so too can your credit utilization ratio, or the extent to which you're using available credit, work for or against you.
While a credit utilization ratio of 30% or less can help boost your score, exceeding that 30% threshold can bring your score down. This means that if you have several credit cards with a collective limit of $10,000, you should make a point to never have more than $3,000 in charges at a single point in time.
Credit card rule No. 4: Find worthwhile rewards
One major benefit of using a credit card is that you'll get access to whatever rewards your issuer is offering. Those rewards might come in the form of cash back, store dollars, or air miles. But before you sign up for a credit card, make sure its rewards are both accessible and useful to you.
Say you choose a card that rewards you with air miles but you only travel once every few years. In doing so, you're running the risk that those miles will expire before you get a chance to use them. On the other hand, if you pick a card whose rewards come in the form of good old cash, you're less likely to lose out.
Along these lines, if you don't own a car, it doesn't pay to choose a card offering 3% cash back for gasoline purchases. You're better off finding a card that gives you, say, 1.5% cash back on groceries, which all humans need.
Credit card rule No. 5: Know your benefits
We just learned that credit cards not only serve as a short-term, interest-free loan of sorts, but reward customers for making purchases. But most cards offer additional benefits, like built-in purchase protection and coverage for stolen items.
In fact, credit cards, by nature, offer a number of safeguards that cash simply can't mimic. When you use a credit card to pay for something, there's a record of your transaction. So if, for example, you buy an electronic that breaks on you 12 days after the fact, and you've lost your receipt, you'll be out of luck if you bought it with cash. A credit card, on the other hand, can provide the proof you need to get your money back.
While paying for purchases with a debit card or cash might help you avoid the temptation to overspend, you'll miss out on so many key advantages that credit card users can benefit from. So don't think of your credit card as the enemy. Rather, think of it as the nifty device you'll be using to build your credit, increase your financial flexibility, and get rewarded for the things you're already buying.