Today I received a question from reader Dani. It inspired me to write this article: Credit Cards- When to Use Them and When to Absolutely Not Use Them
She asks, I’m reading that book that lots of people recommend... the Dave Ramsey one. It suggests getting rid of credit cards all together. We have credit cards, but we haven’t paid a cent of interest on them. We pay off whatever we spend the same day we spend it. We figure we’re “building credit,” but is that really necessary? We also like the rewards points. Six months after our wedding we went on a honeymoon cruise that was 100% paid for by credit card rewards points. However, it does seem “safer” to have no credit cards, that way you can never get in debt trouble.
My answer: It depends on the situation. Here is more information, warnings, and tips for all my readers to asses whether you should or shouldn't be using credit cards.
1-You need credit to build credit. If you are planning on buying any large items with credit such as a car or a home or even if you rent it's important to have a good credit score. For a young couple or person who has a lot of important moves, decisions, and purchases to make, building a good credit score is vital. Credit cards are a simple and effective way of building credit. Check out this post on how to build an excellent credit score and ways to improve a bad one.
2- They are safer than using debit cards. Now that identity and overall theft rates are growing, its more important than ever to protect yourself. Credit card companies protect your purchases and if your card gets stolen they will usually always take the theft charges off. If a debit card is stolen, your whole entire savings can be wiped out. Although the majority of companies (Visa and MasterCard) also protect debit being ran as credit fraud in the same way they protect credit cards, you will still be out of money until the money is proven to have been spent in fraudulent ways and refunded to your account. With zero in the bank account for up to 1-2 months while the companies reverse the theft you may incur fees and fines for being late on payments, etc. Using credit cards, especially for online purchases, is safer.
3- You can make money with your cards. I've made over $5,000 in cash on my credit cards in the last 11 years. That is a significant amount of money. Further, my family has used 10 round-trip flights we earned or got for free from credit cards (which amounts to another couple thousand dollars). I am always bewildered at how I get so much cash back on purchases that I'd make anyway.
CAUTION 1: Building credit through credit cards is tricky. I learned from a credit expert that carrying at least 10% of the limit of the credit card over from one month to the next (accruing a little interest) at least once or twice a year is good. It shows the credit bureau that you have debt and can pay down that debt. This will give you a better credit score. If you are not worried about your credit score this of course would not be a good idea as you will pay interest charges.
CAUTION 2: Before you or a loan company runs your credit score you will want all of your cards paid down to a zero balance for at least a few weeks (a month or two is the best). The higher your credit threshold to debt ratio the better. For example, if you have 3 credit cards that together total $13,000 worth of possible debt and they are all paid off, then you have a 13,000/0 debt ratio which looks awesome to the credit bureau. If you can't possibly pay them all the way off, do your best to have less than a 10% credit to debt ratio. So for this example that would be credit $13,000/$1,300 debt. Each card should have less than 10% on it as well so spread out the debt if you can't get them to zero before a credit report is ran. This is because if you are over 10% credit/debt ratio on both an individual credit card or the entire debt to ratio threshold, you get majorly dinged. Check out this post on credit scores.
CAUTION 3: Opening and closing out cards continually lowers your credit score. Keep your cards open for a long period of time and only close out one card every year or so. If you have cards you no longer want to use, just cut them up.
The exception to this rule is if they have a reoccurring yearly charge on them. I'm a big proponent of not getting into any reoccurring charges on credit cards, bank accounts etc. If there are free versions, I always opt for those. Unless I get free round-trip flights etc. then I'll use the card and the offers and then close it out before the yearly fee hits again. I try to not do that too often.
WARNING: If credit cards are causing you to be constantly over your budget, racking up late payments and interest charges, and you are unable to pay them off each month, cut them up and get rid of them. Credit cards are a temptation and often encourage thoughtless spending. I'll admit that using a credit card makes going over the budget a whole lot easier.
TIP 1: If you don't have a card yet, or if you struggle going over but need a card for online purchases get one with a low credit limit. I started off with my first credit card at a local bank with a $500 limit. After three years I realized that I could handle it. So I applied and got approved for a $3,000 limit card with a high interest rate of 16%. They wanted to see how I would do with such a large limit. Which leads me to tip 2...
TIP 2: If your card doesn't lower the interest rate on a good account every couple of years, call and ask to have your credit card interest rate lowered. On my $3,000 limit with a 16% interest rate I kept a great account so the next year the interest rate dropped to 14% and my credit limit went to $4,500. As I've shown this company that I can responsibly handle credit I'm now at about a 10% interest rate and credit limit is up to $15,000. Call and negotiate your interest rate if you have been with a company a few years, have a good account history, and they have not lowered your rate. This is for when you do carry a balance from one month to the next to show the bureau that you do can pay down debt. The lower the interest rate obviously, the better.
So for you Dani, it sounds like credit cards are a great option to building a great credit history and score. Great job on being so financially responsible.
FOR ALL READERS: Look at all of your options, upcoming decisions, and past history with credit cards. If you can handle them responsibly then I recommend taking advantage of the security and benefits that credit cards offer. If you can't handle them (or if credit cards are costing you money) then Dave Ramsey is right, it's best to get rid of them.
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What’s your opinion?