It may sometimes feel a bit counterintuitive, but you need to take on a bit of debt to become more creditworthy. Banks and other institutions don't just want to know you have money -- they want to see your track record of repaying what you owe. While having and using credit cards is a necessary evil, the trick is using them correctly.
In this episode of Motley Fool Answers, Alison Southwick and Robert Brokamp are joined by Motley Fool analyst Nathan Hamilton, one of our credit specialists, to talk about the most common credit card pitfalls and how you can avoid them.
A full transcript follows the video.
This video was recorded on June 26, 2017.
Alison Southwick: For some people, credit cards are an evil enabler, especially when you consider that the average person who has credit card debt is in for roughly $16,000 on average. But the flip side of that is that 60% of people actually pay off their balances every month. So credit cards aren't all that bad. When managed responsibly they can be a delightful modern convenience.
And joining us today is Nathan Hamilton. He's back to talk about some of the most common pitfalls of credit cards and how you can avoid them. Hi, Nathan! Thanks for coming back!
Nathan Hamilton: Absolutely! How are you?
Southwick: I'm great! So, Pitfall No. 1.
Hamilton: Paying cash advance fees. And for people that aren't familiar, it's essentially using your credit card like an ATM. That doesn't necessarily work with credit card debt too well because what happens is there are two fees that you're going to be hit with. One is a transaction fee. If you hate paying ATM fees, for using a cash advance you're going to be hit with a 3% fee just for accessing cash. And the other part of it is generally you're going to incur a sky-high APR interest charge for borrowing that money and taking a cash advance.
If you look at it, it's huge business for banks. I know we've talked before about banks making money off of fees, but cash advance fees, when you look at the grand scheme of things, No. 1 is you've got interest charges. That's where banks earn their money. Second is interchange, which is just a processing fee. No. 3 -- $26 billion is what banks earned in 2016 from cash advances.
Hamilton: It's huge.
Robert Brokamp: Why is there a difference between the rate on cash advance fees and a regular purchase? Like if I use it at Amazon or something like that?
Hamilton: If you look at it from a credit card issuer's perspective, that's not a good budgeting behavior. When you're having to tap a high-interest credit card to get emergency funds, a credit card issuer is going to say, "You're probably not going to be paying off on time."
Brokamp: It's a red flag.
Hamilton: It's a red flag.
Southwick: So the people who are using cash advances are people who have maybe already maxed out their credit and they need more?
Hamilton: It's more needing cash.
Southwick: Just need cash.
Hamilton: Looking at it, your available credit limit to borrow for purchases is going to be higher than what your cash advance limit is. It's just accessing cold, hard cash.
Southwick: So, Pitfall No. 1 is avoid cash advances. Pitfall No. 2 is ...
Hamilton: This is getting into the weeds, but paying before the statement date versus the due date and here's why it makes sense. On the statement date your credit card balances are reported to the credit scoring bureaus, and what happens there is they calculate what's called your credit utilization ratio, which is looking at your borrowing versus what you have available and assessing your score based upon that information.
So if you pay on the due date, your balances have already been reported. If you pay before the statement date, you're getting that balance down to zero. A zero balance is being reported to the credit bureaus. Your credit utilization improves and so your FICO score improves.
Southwick: Now on the previous show when we had you on to talk about credit scores and how to improve them, you talked about how you pay off your bills on the 10th of the month, the 20th of the month, and the 30th of the month. Is that for this reason?
Hamilton: Not only does it help me budget and stay within my allotted limit every month, but it essentially means I'm reporting a zero balance to the credit reporting bureaus, and from there my FICO score improves.
Southwick: And maybe you just love paying bills.
Hamilton: I just love it.
Southwick: Why do it once a month when I can do it three times?
Hamilton: I love spending and paying bills. It's my favorite thing.
Brokamp: I'm going to assume you are an organized person.
Hamilton: I am.
Brokamp: I have seen your desk, or what people might consider a desk ...
Hamilton: A minimalist.
Brokamp: It's a table. There's like nothing on it.
Southwick: You would not know that someone actually uses that desk because it's so clean.
Hamilton: Yes, it is.
Southwick: What is the third pitfall for people to avoid when it comes to credit cards?
Hamilton: This is one where you've got to look at the fine print when you're either applying for a credit card or using them. But it's missing a balance transfer period for the promotional APR. So, for balance transfers, some cards will be lenient and say you can transfer the balance anytime. We'll give you the 0% APR for 15 months. Others will say, "You can only do so within this 60-day period from account opening [a bunch of legal disclaimer stuff in italics and a small font] that you have to abide by to get that 0% introductory APR." So it's just paying attention to the details.
Don't fall into that pitfall, because if you look at balance transfer cards I would say half of them have these random requirements on them.
Brokamp: I know that some of the requirements that it used to be -- I haven't paid attention as much lately -- but you had to also pay everything exactly on time, so if you did the balance transfer and then you missed a payment, then you basically lost that teaser rate.
Hamilton: I don't know how it works now, but I know there's [been] various legislation [passed] that came after the financial crisis that was more of an advocate for the consumer, and they removed some of those stricter regulations. I don't know what the exact plan is right now, but I definitely want to look at it because if you miss a payment you're hurting your FICO score.
Southwick: And probably anytime you're doing a lot of credit card ju jitsu, you probably want to read all the fine print just as closely as possible.
Hamilton: The funny thing you look at when you're reviewing all the credit card details is how much legal language there is in there. Qualifying balance transfers or qualifying new cardholders for promo period asterisk. There are all those details, but thankfully they're presented in a standardized format that is pretty easy to understand.
Southwick: What is the fourth and final pitfall that you suggest people avoid when it comes to using credit cards?
Hamilton: This is going to sound like an odd one, but I recently learned this based upon some research I came across in the market. It's paying the annual fee. So some credit cards you get away with a zero dollar annual fee. There's no charge to essentially have the card. Other ones charge an annual fee. But if you call up your credit card company, they're pretty willing to waive that fee if you're a good cardholder.
And the research I came across is that 80% of people requesting a fee waiver for their annual fee were granted it, so it's not a small number and I haven't done it before, but I sure as hell know that I'm going to be calling up any card companies that I have right now.
Brokamp: Give it a try!
Hamilton: On the podcast.
Southwick: What are some of the lower versus the higher annual fees that you've encountered in your research?
Hamilton: For a premier card, it's going to be several hundred dollars.
Southwick: Oh, that's no joke.
Hamilton: There are some cards that are $450-550 based upon some cards that are on the market now. For more consumer everyday cards, they run anywhere from $50 to under $100.
Southwick: So getting it waived -- that's take yourself out to dinner money.
Hamilton: Just like I don't like paying bills, nobody likes paying fees.
Southwick: Exactly. So, if our listeners want to learn more about managing your credit better, you can head to Fool.com/creditcards. We also have lists like which credit cards are the best for travel rewards, or cash back, or if you want to move over some of those big balances. We're not judging. We'll find you some good deals with credit cards with 0% APR. But again, read the fine print.
Nathan, thank you for joining us again! This has been fun and I learned a lot.
Hamilton: Thank you!
Brokamp: So have I!
Southwick: That's a big deal when you learn a lot. Mr. Smarty Money Pants.
Alison Southwick has no position in any of the stocks mentioned. Nathan Hamilton owns shares of Amazon. Robert Brokamp, CFP has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon. The Motley Fool has a disclosure policy.