Credit cards are not an inherently bad product. They allow consumers to easily finance large purchases, some cards come with great rewards, and a solid history of responsible credit card usage can make it easier to get a good interest rate on a house or car. However, it's important to keep in mind that credit cards are a business, and just like any business, the companies that issue credit cards are trying to make money. Here are three ways you can avoid giving credit card issuers any more money than you need to.
Know why credit card companies give such great rewards
Competition has heated up in the credit card industry in recent years, and banks are offering better introductory bonuses and reward programs than ever before.
While introductory bonuses are designed to entice people to sign up for the cards, keep in mind that ongoing rewards programs exist for one reason -- to get people to spend money. If you only need an extra 1,000 airline miles to get a free flight, and your card gives two miles per dollar spent, it can be tempting to go spend $500 on something you don't really need, just to get the miles.
Using credit card reward programs makes perfect sense -- if you never carry a balance. Even the best credit cards offer reward rates of 5% or 6%, and this is usually only on certain types of purchases. It isn't tough to see how paying interest at a rate of 15%, 18%, or more can erode the value of the rewards you get.
In addition to leaving you in debt, misusing credit card rewards programs can negatively impact your credit score. According to myFICO, the balances of your credit cards relative to your credit limits is a major scoring factor. So, not only will you be on the hook for the principal and interest, but you could find it tougher to obtain other credit as a result.
Don't fall for 0% APR financing from store credit cards
Many retailers offer these deals -- let's say that you're shopping for a new TV and you see that the store is offering 24-months interest-free financing on purchases of $2,000 or more. Sounds like a good deal, right?
The problem is what happens after the 24-month introductory period is up. You may think that your account will begin to accumulate interest from that point on. Rather, if you have a remaining balance of even one cent at the end of this time, you'll be charged all of the interest that would have accumulated all along.
These offers are known as "deferred interest" financing. You don't actually have a 0% interest rate. Your account has an interest rate, and typically a rather high one -- close to 30% is common. The issuer simply agrees to not hold you liable for paying the interest if the balance is paid in full in the agreed-upon amount of time.
For example, if you buy a $3,000 living room set and get 12 months of interest-free financing with minimum monthly payments of $100 and a standard interest rate of 29%, you can expect to accumulate nearly $700 in deferred interest. So even though your monthly payments will bring your balance to $1,800 by the 12th month, your 13th statement could show a balance due of $2,500 once the deferred interest kicks in.
Before you agree to one of these deals, be sure that you can pay the balance in full before the interest-free period runs out. Or better yet, find a traditional (non-store) credit card with a 0% APR introductory period, which will truly be no-interest financing.
Rebuilding your credit doesn't have to cost much
It's well known that if your credit score is low, you won't be able to qualify for the best credit card offers. But that doesn't mean you should accept ridiculous fees and interest rates, either.
Some card issuers will lead you to believe that you have no other choice when it comes to rebuilding credit. For example, the First Premier Bank credit card comes with a 36% APR, a $95 initiation fee, a $45 annual fee, and a $6.25 monthly fee after the first year. If you're lucky enough to qualify for a limit increase after maintaining a good payment record, you'll be assessed a fee equal to 25% of the increase.
A far better option is to get a secured credit card, which works and looks like a standard credit card, with one big difference. Before the bank will issue a card, you need to make a security deposit in the amount of the card's credit limit. While it may seem inconvenient to have your money tied up, the costs of a secured card are much more reasonable.
Many banks issue secured cards, so shop around. For example, the Wells Fargo Secured Visa has a $25 annual fee and a 19.24% APR -- both of which are competitive with standard credit cards. Plus, your history will be shared with the credit bureaus and you can potentially upgrade to an unsecured card at a later time.
The bottom line on credit cards
Credit cards can be your best friend or worst enemy. When used properly, credit cards can help you build a rock-solid FICO score, give you the peace of mind that comes with not carrying cash, and even give you some nice rewards and other benefits. Just be sure to avoid the costly traps mentioned here, or else credit cards can do more harm than good.
