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There are more than a billion credit cards in existence, and the average American holds three or more. Our society is very reliant on credit cards for their convenience, and we enjoy the many perks they offer, like fraud protection and rewards programs. Cards also help you build your credit score, which can help you qualify for loans and get lower interest rates. Still, many of us don't know how to take full advantage of our credit cards.
Here are seven myths you should no longer believe. Set yourself straight, and you may end up saving -- or receiving -- hundreds or thousands of dollars.
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Myth No. 1: You don't need a credit card
For starters, many people assume they don't need a credit card. Sure, you can get by without one. You can pay for just about anything with cash or a check -- or a debit card. And there's even a meaningful upside to not using credit cards: You won't spend as much. Studies have shown that we tend to spend more when we use plastic, because we feel the loss of money less when we do so. If you only have $20 in cash in your pocket, you might think twice before spending $5 on a coffee or some other treat. But if you have a charge card with a $20,000 credit limit, what's $5?
Yet there's a very good reason to have at least one card and to use it: It will help you establish a good credit record and credit score. You may think a high credit score is only good for securing lower interest rates on loans or getting credit cards with higher limits and better rewards. However, a high credit score can improve your odds of being approved for a rental home or even getting a job, because a solid credit history is seen as evidence of your reliability.
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Myth No. 2: Credit scores are based on how often you pay your bills on time
If you want to beef up your credit score, you'll need to do more than just pay your bills on time. Although payment history is a major factor in your credit score, there are many others. Check out the components that determine your FICO score, which is the most commonly used credit score:
|
Component |
Influence on Credit Score |
|---|---|
|
Payment history |
35% |
|
Credit utilization (amount owed vs. limit) |
30% |
|
Length of credit history |
15% |
|
New credit |
10% |
|
Other factors such as your credit mix |
10% |
Data source: MyFICO.com.
Your payment history is the most important factor, but your credit utilization ratio (your total debt divided by your available credit) is a close second. If you're saddled with enormous mortgage payments, for example, that can make you a riskier borrower than someone with relatively little debt. If you've nearly maxed out your available credit limits, that can hurt your score.
The FICO formula also favors people who have lengthy credit histories and penalizes those who have recently taken on new credit, perhaps by opening several new credit card accounts.
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Myth No. 3: Having a high credit score doesn't matter that much
If you're not yet sold on the value of keeping your credit score as high as you can, consider the following table, which shows you some recent sample interest rates that borrowers with various credit scores might be offered on a 30-year, $200,000 mortgage -- along with the difference that rate will make in your payments:
|
FICO Score |
APR |
Monthly Payment |
Total Interest Paid |
|---|---|---|---|
|
760-850 |
3.608% |
$910 |
$127,668 |
|
700-759 |
3.83% |
$935 |
$136,720 |
|
680-699 |
4.007% |
$956 |
$144,030 |
|
660-679 |
4.221% |
$980 |
$152,975 |
|
640-659 |
4.651% |
$1,031 |
$171,302 |
|
620-639 |
5.197% |
$1,098 |
$195,226 |
Data source: MyFICO.com.
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Myth No. 4: It's OK to pay a credit card bill late now and then
You might reasonably assume that as long as you almost always pay your bills on time, you'll be fine. That's not true, though, because many credit cards feature a pernicious element: the "penalty APR."
With a penalty APR, if you're days late in making a minimum payment, your credit card issuer could charge you a far higher interest rate on the outstanding balance -- often between 25% and 30%. If one or more of your cards has a penalty APR, either close those accounts or make extra sure you never trigger the higher rate, which could leave you neck-deep in credit card debt.
Even if you're safe from a penalty APR, the lowest interest rates credit cards offer today are between 12% and 14%. Meanwhile, the highest interest rate a bank will pay you in a savings account is only about 1.2%. That means a single late payment could be very expensive.
Imagine you owe $10,000 on cards and are unable to pay it all off. If your interest rate is 20% and you just leave the debt there, you'll soon owe $12,000, and a year after that, you could owe $14,400 -- and that's assuming you don't charge anything else to the card.
On top of the hefty interest charges, your card issuer may sock you with a late fee for each missed payment. A spotty payment record can also shrink your all-important credit score, costing you more whenever you want to borrow money.
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Myth No. 5: It's not that bad to pay the minimum due
True, most people know it's best to pay more than the minimum due when your credit card bill arrives. But you might not fully grasp just how much better it is. Paying the minimum will keep you in debt for a long time, and it will generate gobs of extra money for your credit card issuer(s).
For example, imagine you owe $20,000 on credit cards and you're being charged a 25% interest rate. If your minimum payments are 3% of your balance, you'll start out having to pay a whopping $600 per month, meaning you'll have to come up with $150 per week. If you can't, your balance will be growing, digging you deeper in debt. But what if you do make that $600 payment and all future 3% payments? Even then, it will take you more than 30 years to pay off the debt, and your total payments will exceed $63,000 -- all for a $20,000 balance owed.
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Myth No. 6: If you have steep debt, bankruptcy is your best bet
What if you're already swimming in debt? You may think your only way out of your predicament is to declare bankruptcy, but you'd be wrong. There are several strategies for paying off that debt:
- Negotiate: You may not realize it, but you can call your credit card company and ask for a lower interest rate. Many lenders will cooperate in order to keep you around. If you've been a good customer for years, then remind the company of that -- and the fact that you can always transfer the debt to another lender with better terms. Shaving just a few percentage points off your rate can save you thousands as you pay down your balances.
- Tackle highest rates first: The most efficient way to pay off debts is to tackle your highest-interest rate debt first, because it costs you the most. For example, if you owe $5,000 on a car loan charging you 6% annually and $20,000 in credit card debt with a 16% interest rate, you would tackle the credit card debt first, as it would save you the most money in the long run.
- Tackle smallest debts first: This approach may not seem as logical, but it can be a powerful motivator. The idea is to quickly reduce the total number of debts you have, rather than the total amount of money you pay to lenders. You start by listing all of your outstanding debts and ranking them by amount owed. Then, regardless of their interest rates, pay off the smallest debt first, then the next-smallest one, and so on until are your debts are repaid. Every time you pay off a debt, it will feel like a victory -- and you'll also have one less creditor breathing down your neck.
Transferring your credit card balance to another card with better terms can be effective, too. If you're looking for a good balance-transfer card, aim for one that will charge you no interest for at least 15 billing cycles. Be careful, because if you still owe money after your interest-free cycles run out, some cards will then start charging you a steep interest rate. Know, too, that some cards will charge you a balance-transfer fee of about 3% to 5% of the amount you transfer from another card. That can still be worth it sometimes, but favor cards that charge no such fee.
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Myth No. 7: There's little upside to credit cards beyond building a credit score
Finally, if you pay your credit card bills in full and on time, you may think there's little more to be done. Think again, though, because while using cards responsibly can help you avoid debt and other disasters, using certain cards can actually help you make money.
For example, you can collect cash or rewards by using your credit cards. There are lots of great cash-back credit cards worth considering. Some cards pay you 2% cash back on all your purchases, while others offer up to 5% back on certain categories, such as supermarket spending. Some cards have preset cash-back rates for certain categories, while others rotate categories that earn bonus rewards every three months -- sometimes even letting you choose the categories.
If you do a lot of shopping, think about where you spend the most money, because many retailers offer cards that give you discounts when you shop with them. If you spend a lot at Amazon.com, for example, you can get a card that pays you 5% cash back on Amazon purchases. So if you spend $250 per month at Amazon, that's $3,000 per year -- enough to earn $150 back. Other stores offering credit cards include Target, Costco, Gap, Kohl's, Lowe's, Staples, TJX, Toys R Us, and Wal-Mart. Some shopping cards offer other perks, too, such as free shipping on items purchased at the sponsoring retailer, while others might let you return items without a receipt or donate money to charity whenever you use the card.
If you travel a lot, consider the best travel credit cards, which are essentially rewards cards focused on your travel-related spending. Some are dedicated to one airline or one hotel company, offering benefits and rewards when you frequent that company. Others are broader, offering a range of travel-related benefits and rewards from a wide array of companies.
