Using credit cards for purchases is a common practice. Though there are benefits to using credit cards, it’s important to also understand the dangers of credit cards so that you can take the proper steps to protect your financial future.
Temptation to Overspend
The feeling that you have more money than you do – and the temptation to overspend – is one of the biggest risks of credit cards. It’s easy to rationalize that you’re going to pay for something later even if the reality of your finances says otherwise. Carrying a balance month-to-month causes you to pay interest on that debt; when more of your money is going toward interest, you have less to allocate toward your regular spending and the cycle can spiral.
How to avoid it:
The best way to avoid overspending is to create a budget – and stick to it. There are still benefits to using your card if you don’t carry a balance month-to-month, such as protecting online purchases, earning rewards or building credit, but sticking to your budget can help ensure that you don’t spend more than you have.
New Credit Applications
Some credit card companies offer special entry rates or additional perks for new applicants. That could tempt you to apply for new credit cards that you don’t need, but each application for a new line of credit results in a hard inquiry. These hard inquiries stay on your credit report for two years and can impact your credit score negatively.
How to avoid it:
While new offers may look beneficial, you should limit your applications to ensure that your credit report portrays someone who is responsible with their credit.
Confusing Credit Card Terms
The terms and conditions in a credit card agreement may be dense and unclear. They typically give significant rights to the card issuer, such as the right to change terms of the agreement, but it’s not always clear what you’re agreeing to.
How to avoid it:
Carefully read the fine print to make sure you understand the interest rate (including if you’re receiving an introductory rate), the reward structure and redemption process.
Late Payments and Heavy Interest Charges
Carrying a balance month-to-month can result in paying a significant amount toward interest, meaning you’re paying more than whatever you purchased was worth. Plus, if you miss a payment, late fees could increase your bill again.
How to avoid it:
Make payments on time and do your best to pay more toward your credit card debt each month than the minimum required.
Paying Just Minimum Payments
Credit card companies want you to pay the minimum payment each month; that keeps you in good standing but allows them to collect the maximum amount of interest on your balance. Paying the minimum credit card payment can spread your debt payments over years and lead to a significant portion of your payments going toward interest.
How to avoid it:
Try to pay your credit card off each month. If that’s not possible, determine how much you can allocate to debt payments each month and practice the debt snowball method. This is when you pay the minimum amount on all but your highest-interest debt – which is typically a credit card. Put as much as you can toward that debt until it is paid off, then roll that entire payment into the debt payment with the next highest interest rate.
Impact on Your Credit Score
While you may think that using your credit card improves your credit score, the opposite may be true. When you build up a balance, you use more of your available credit. That increases your credit utilization ratio and can decrease your credit score. Basically, you get penalized for using more than a certain percentage of your available credit – typically about 30%. If your credit score goes down, you could get an unexpected rate increase because the company thinks you are a higher risk for defaulting on your credit card debt. Not to mention, credit scores are important for determining interest rates of large purchases, such as homes or vehicles.
How to avoid it:
The best way to prevent a negative impact on your credit score is to pay your credit card bills on time and avoid carrying over a high balance. You should also monitor your statements and credit reports for fraud to ensure that someone else’s actions don’t bring down your score.
Protecting Your Future
Making smart choices around credit is one of the foundational pieces of building a strong financial future. Other actions include protecting your livelihood with life insurance and investing for retirement. Talk with a Farm Bureau agent to identify the right steps for you and put strategies in place to build your future.