There are a few universal truths about credit cards. For example, most of us know that maxing out credit cards is bad, not paying them on time is even worse, and that credit cards usually come with high interest rates relative to other forms of lending. However, there are several myths involving credit card use that we'd like to clear up. We asked five of our contributing writers to set the record straight on these credit card tales.
Jordan Wathen: While credit cards can help you build and maintain a solid credit score (I have some for exactly this reason), far too many people falsely believe you must carry a balance, and thus pay interest, to get any benefit on your credit score. This is simply not true.
Having a credit card on your report can help your score in a number of ways. First, as the account ages, it will extend the average age of your accounts, a meaningful factor in your credit score. Second, if unused, it will also help your utilization rate (the amount of credit you use versus how much you could use), another key factor in your score. Notably, any paid interest on your balances is not a scoring factor.
By paying your credit cards in full each month, you'll get all the benefits of having a credit card on your credit report without paying a penny in interest. Given that credit card rates can be as high as 10 times the rate on a mortgage or 15 times the rate on a car loan, you'd be smart to pay your balance in full each month. You'll never get a better guaranteed return than the return on paying down credit card debt.
Matt Frankel: As Jordan correctly pointed out, you don't need to carry a balance on your credit cards to boost your credit score. On the other hand, a high credit card balance won't necessarily hurt your score.
The second-largest category in the FICO scoring formula is "amounts owed," which contributes 30% of the information in your credit score. However, this refers more to the percentage of your available credit you're using, not to the dollar amounts.
For example, let's say that you owe $1,000 on your credit cards, and that your combined credit limits add up to $2,000. In this case, you're using 50% of your available credit. Now, let's say your friend owes $5,000 on his credit cards, but he has $40,000 in available credit. Even though he owes five times as much as you do, he's only using 12.5% of his available credit, and therefore could look better to prospective lenders (and to the credit scoring people).
So, it's not about how much money you owe. It's about how much you owe relative to how much is available to you.
Dan Caplinger: Credit card companies have acquired a reputation for being cutthroat financial institutions that prey on the disadvantaged. Yet credit card companies are often willing to negotiate on certain matters, either when problems arise or when you just want to get a better deal.
Complaints about issues such as finance charges and late payment fees are common, but relatively few people ever actually try to fight those fees. With a little effort on your part, many customer service representatives are willing to reverse fees, particularly if you have a good track record of timely payments so it's clear that a late payment is an uncommon mistake.
Similarly, if you're looking to upgrade your card, you can often get a deal just by asking. Higher credit limits, lower interest rates, or larger rewards for using your credit card aren't always just a phone call away, but it's worth the minimal effort involved to see if you can get a better deal. With so much competition among credit card companies, you're a valuable customer, and you can take advantage of your leverage by trying to get your existing card company to match what you can get with one of its rivals. If your card company won't work with you, then making good on your threat can leave you better off in the long run as well.
Sean Williams: One of the most pervasive myths I've heard in my lifetime is that consumers should close unused credit accounts.
The reasoning behind this idea is pretty simple: Open credit accounts are just waiting for you to go crazy one day and charge up thousands or even tens of thousands of dollars in goods and services. Thus, closing unused accounts is a smart way of protecting yourself from a weak spending moment. By closing your accounts creditors should look upon you as a responsible adult.
The reality, though, is that hastily closing your credit accounts might not be such a smart idea after all.
For starters, credit card companies want to know you're a responsible credit user and able to make your payments on time. For that to happen you should have two or three credit accounts at minimum open at all times. Having just a single open account, even if it is the only one you use, might not be enough "history" to make another lender comfortable enough to extend you a line of credit.
Another concern is that your account history plays into your credit score. If you close an account with a rich history of benefits, such as timely payments, you could be canceling out a major boost to your credit score. Although you might be lowering your available credit and your intentions might be good, your credit score could actually drop if you close an account with a long history of purchases and on-time payments.
Lastly, more open accounts (within reason -- this doesn't mean open 20 accounts right now) should mean more available credit and less credit utilization. Credit lenders look at how much credit you're using, and can use this to weigh whether to lend to you. Additionally, credit agencies use your credit utilization ratio when calculating your credit score.
The next time you feel the urge to purge your old accounts, think hard about whether there's really a benefit to removing them from your credit history.
Jason Hall: For years, only the wealthy really benefited from having a credit card. With the cards' expensive annual fees, and the fact that many establishments that accepted them were high-end "classy" joints that didn't cater to the masses, there just wasn't much point for the average Joe or Josie. However, that hasn't been the reality for credit cards for years. Almost everyone with at least decent credit can use and benefit from credit cards today.
The credit card business has become incredibly competitive, and just about every retailer and restaurant accepts a major credit card now. Given this competition, there are literally dozens of rewards programs, as well as 0% promotions that can benefit most people. In short, credit cards can save you money, if you can be disciplined in your use.
A few strategies:
- Treat them like cash. Don't spend money on the card unless you're prepared to pay it off that same day.
- Find a rewards card that gives you the most benefit based on your top spending categories, such as groceries or travel.
- Take advantage of discounts or free financing with branded store cards.
- Transfer balances from high-interest cards to low- or no-interest cards.
Using your credit card for daily expenses can be rewarding and put money back in your pocket. Just be aware of how much you are spending, as some studies have shown that credit card users will spend more on average for similar purchases.
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