The Pros & Cons of Credit Cards: Everything You Need to Know
Like any powerful tool, credit cards can be incredibly beneficial if used correctly but dangerously adverse when handled with the wrong mindset. Recognizing both sides of this double-edged sword will help you better navigate the credit space by enabling you to make the most of the positive features while avoiding the majority of the drawbacks.
Doing so could therefore be the difference between racking up expensive debt and damaging your credit standing or earning a free rewards vacation. Thus, for good reason, WalletHub has compiled a guide to the advantages and disadvantages of credit card use in order to bring some transparency to the table and help you answer the question: why get a credit card.
- Credit Building – Credit card account information is sent to the major credit bureaus on a monthly basis, allowing you to build a solid history or effectively correct any mistakes relatively quickly. You don’t even need to use your credit card to benefit. As long as you have an open account that is in good standing, positive information will fill your credit files.
- Convenience – You don’t want to always carry cash around, especially not enough to make big-ticket purchases. Not only is a credit card easier to conceal and carry, but it’s also a lot easier to keep tabs on a card than the exact amount of cash you have with you. In the unfortunate event your credit card is lost or stolen, you aren’t liable for any unauthorized charges and therefore aren’t out any money. You can’t say the same for cash.
- Rewards – Whether they’re in the form of cash back, airline miles, hotel points or gas rebates, many credit cards provide rewards that not only help subsidize the cost of purchases, but also provide certain unique amenities. By signing up for a rewards credit card, you are effectively joining a group for which membership has its perks. For example, some cards provide discounts and exclusive access to shows, ball games and concerts; VIP treatment in airports and hotels; concierge services; special gifts; and much more.
- Pay Over Time – For most people there comes a time, for whatever reason, that we need a few extra months to fully pay off something that we need to purchase. A credit card not only provides that ability, but — depending on your credit standing — might allow you to do that without paying any interest by utilizing a 0% APR credit card.
- Balance Transfers – If you already have debt (including but not limited to credit card debt), 0% balance transfer credit card offers represent one of the easiest ways to lower the cost of your interest charges.
Grace Period – You have at least 21 days from the time you receive your credit card bill each month to pay it. This means that if you pay your bill in full every month, you may have up to 51 days (21 day grace period + 30 days in a billing cycle) before you have to pay your credit card issuer back for the purchases you make.
This not only helps your cash flow, but also comes in handy in the rare event that you detect unauthorized charges on your account. A credit card gives you a substantial buffer to sort out any problems before they truly affect your bank account and the rest of your finances.
- Theft Protection – Credit cards have $0 liability guarantees, meaning you won’t lose any money if your card gets lost or stolen. What happens with cash in such an instance?
- Online Shopping – While you may be able to use a variety of payment methods when shopping online – including credit cards, debit cards, prepaid cards, gift cards and electronic payment accounts like PayPal – credit cards are best suited to the task because virtually all merchants will accept them, they offer the best fraud protection, and they provide the most generous rewards programs.
- Hotel & Rental Car Reservations – Rental cars and hotels are generally regarded as expenses that necessitate the use of a credit card. While that’s not necessarily true – debit cards are also a viable option in most circumstances – credit cards do make these types of transactions much easier. Rental companies and hotels typically place a hold on your account for incidentals, and it’s better to have your credit line tied up than the actual money in your bank account.
- Improving Financial Literacy – Credit cards are an important aspect of teaching your kids financial literacy. If used correctly by parents, credit cards can be an excellent tool for teaching kids to not spend beyond their means, even if given the temporary ability to do so.
- Expense Tracking – Credit cards make it easier for anyone – whether you are a small business owner or an everyday consumer – to track their spending over time. This pays dividends when it comes to household budgeting, cash flow management, and more.
- Small Business Perks – Business credit cards provide a number of helpful features tailored specifically to the needs of small business owners. This includes higher rewards earning rates on things like office supplies and telecommunication services, robust expense tracking tools, and the ability to give employees cards with customizable limits that you, as the owner, can earn rewards on.
- Currency Exchange Rates – Credit cards are great for foreign travel because Visa and MasterCard automatically provide some of the best exchange rates possible. While 90.2% of credit cards have fees for transactions processed abroad, these fees can easily be avoided with no foreign transaction fee credit cards. As long as you also steer clear of dynamic currency conversion, a credit card will be a useful, cost-saving travel tool.
- Car Rental Insurance – Credit cards automatically provide a certain level of supplemental auto rental insurance, which covers you in the event of damage to your rental car. That means you don’t need to buy the insurance being offered by the rental company. In fact, if you do buy it, the coverage your card provides will be nullified.
Extended Warranties – Many customers waste money purchasing extended warranties without knowing that their credit cards often provide this type coverage already.
The availability of such free protection represents “yet another reason why consumers should generally avoid buying extended warranties,” says Ahmed Taha, professor at the Pepperdine University School of Law. “Extended warranties [that you pay for] tend to be very bad deals for consumers because the chance is very low of a product breakdown in the period between the end of the manufacturer's warranty and the end of the extended warranty, and because repair costs are also fairly low.”
- Travel Insurance – Credit cards provide insurance against cancelled trips, missed connections, lost luggage, and even death. The amount of coverage you get depends on the card you have, so make sure to look into the details before traveling.
- The CARD Act (applicable only to consumer credit cards) – The Credit CARD Act of 2009 is itself one of the biggest reasons to use a credit card. Because of it, you no longer need to worry about getting a credit card and having the majority of your credit line be consumed by fees or having your interest rates increased without cause.
Overspending and Debt – When we make purchases with a credit card, there can be a tendency to spend more than we would have with cash. It’s a fairly basic concept – when our payments aren’t tangible, they don’t feel real. And this is especially true if we know we won’t have to deal with the bill for weeks to come. Many people also make the mistake of viewing their credit cards as supplemental forms of income, which leads them to shop based on their desires rather than necessities. Doing so can lead to dire consequences, rendering the credit card a burden rather than an advantage.
Of course, habitual overspending with a credit card will inevitably leave you saddled with some very expensive debt. And from there, it is easy to find yourself unable to make monthly payments, putting you at risk for delinquency, collections, or even a lawsuit.
- Fraud – Although you are assured of $0 liability for unauthorized transactions made with your account, rectifying them and disputing the charges can prove to be a hassle. Furthermore, fraud can also cause temporary damage to your credit report if it causes you to miss payments. Therefore, it is extremely important to protect your private financial information and check your credit card statements for errors each month.
- Fees – While some of the fees that credit cards charge may be worth paying for the perks they unlock – such as annual fees for certain rewards cards – there are others that you can steer clear of with proper account management. Examples of such fees include the cash advance fee, account overdraft fee and foreign transaction fees.
- Deferred Interest Financing – It’s become common practice for credit card companies to offer extended 0% interest introductory periods to customers interested in paying off certain purchases over time. Such offers can be a great deal, but you need to steer clear of retailer-affiliated 0% deals. More than 70% of major retailers offer some form of financing, and 49% of them use what’s known as deferred interest financing. Under a deferred interest financing plan, if you ever miss a payment or there is even the slightest of balances remaining at the end of the intro period, interest will retroactively apply to your entire original purchase amount. That means you’ll end up paying a lot more than you’d originally planned for.
Toxic When Misused – While credit cards are very useful for credit building, the influence they have on your credit score has a flipside as well. If you utilize your credit card poorly – by incurring too much debt, becoming delinquent, etc. – this will indubitably be reflected in your credit report. This, in turn, this will reduce your chances of acquiring good rates on future loans, apartments, credit cards, etc.
What’s more, if you fail to make a couple of consecutive monthly minimum payments and you become delinquent, your creditor will eventually pass the debt responsibility onto a debt collector. And, if their resulting hounding does not prove effective, a lawsuit could soon follow. In other words, the repercussions of serious credit card debt are pretty severe.
- Short-Term Credit Hit – Each time you open a new credit card account, your credit standing will take a short-term hit, lasting a few months. It’s therefore a good idea to never open a credit card right before you need the best credit score possible, such as if you are applying for a loan.
- Fine Print – Credit card application disclosures are notorious for being long-winded and lacking in transparency, rendering them difficult to read. Nevertheless, in order to avoid surprises such as increased interest rates or unexpected fees, one must attempt to tackle the terms and conditions in the credit card agreement.
- No Business CARD Act – Unlike consumer credit cards, business credit cards lack the protection of the CARD Act. Perhaps most importantly, this means that creditors can increase the interest rates on existing balances held on business credit cards whenever they want. Some issuers, however, have taken the proactive step of extending certain aspects of the CARD Act to their business-branded products.
- No Preset Spending Limit – Some credit cards have dynamic spending limits that can change monthly based on your usage habits and fluctuations in the economic environment. They are known as No Preset Spending Limit credit cards. Not only do such cards make it difficult to manage your credit line and plan expenses, but they also report information to the major credit bureaus in such a way that reflects a mistakenly high credit utilization ratio and causes you to incur undue credit score damage.
Household Income System – Although the CFPB’s decision to allow the use of shared income on credit card applications was viewed as a significant victory for stay-at-home parents, the ruling also chips away at the ability of credit card issuers to judge how much credit to extend to us based on our income. That’s because an applicant only has to list individual debts. Credit card underwriters are therefore unable to determine how much disposable income an applicant actually has.
In other words, someone could apply for a credit card by listing their combined income with a spouse, along with their personal debts. But what if the spouse also has a significant debt to which some of that shared income is already allocated? Then there wouldn’t be as much money left over to pay for that new credit card, increasing the odds of default.
The bottom line is that while credit cards are often maligned as conduits to debt and overleveraging, they can truly be quite useful if used correctly. Whether it’s building the credit history necessary to convince a bank you are trustworthy enough to merit a loan or effectively lowering the price of all your purchases through rewards, a credit card has the potential to improve all aspects of your finances.
Moreover, the credit card industry is perhaps as fundamentally strong as it’s ever been, thanks to the CARD Act. Therefore, no matter whether what type of card is in your wallet – whether it is a credit card for excellent credit or a second chance credit card – there’s no shortage of reasons to use this type of spending vehicle if you can navigate around the drawbacks.
Image: Jean Valley/Shutterstock
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