Like a lot of young people, I had credit card debt when I was in my 20’s. I threw away a lot of money by paying interest. But the solution to this problem is not cutting up credit cards or freezing them in a block of ice. Instead, it’s important to develop the discipline to use credit cards properly so that you can take advantage of all the benefits.
1. Using credit cards helps build your credit rating. When you are ready to buy a car or a house, it will be very difficult if you don’t have a credit history. Regularly using credit cards can help build that history. It’s important to pay off your cards every month and to avoid going over your limit on a regular basis, or your credit history can work against you.
2. Using credit cards provides extra protection for your purchases. If you pay cash, you lose the ability to contest a charge if a purchase turns out to be substandard. A merchant is much more likely to refund your money in order to maintain its good standing with your credit card company. If they don’t, you can directly contest the charge through your card issuer. There are often also additional benefits such as rental car insurance or free warranty extension. Using a debit card does not offer you these protections, and if your card is stolen, the thief has direct access to your bank account. The only thing I use my debit card for is ATM withdrawals.
3. Using credit cards can save you money. There are all sorts of cash back programs offered by various credit card issuers. Make sure you find a card without an annual fee, or you could find your savings negated. I also avoid cards with rewards like air miles or money toward a car purchase, as they require you to spend your savings on a specific item. I currently use three credit cards, an Amazon Visa (3% cash back on my Amazon purchases), an REI MasterCard (5% cash back on my REI purchases), and a Fidelity American Express (for most other purchases). The Fidelity Amex gives me 2% cash back on all purchases, which goes directly into my Fidelity brokerage account. Because Vanguard has lower expense ratios, I actually leave the Fidelity rewards as cash reserves and invest an equal amount in my Vanguard brokerage account.
4. Using credit cards helps you track your spending. Stephen and I are pretty good about tracking all our purchases, even when we use cash. But if you have a hard time with this, using a credit card will allow you to effortlessly track your spending. Most cards have an online website where you can view all of your historical transactions and You can even download them directly into a spreadsheet or budgeting program.
If you are concerned about using credit cards without going over your budget, start budgeting with cash. Once you are confident in your ability to manage your money without going over budget, then apply for a credit card. Don’t worry about having a large credit limit at first (after all, the point is NOT to spend up to your limit). As you build up your credit over time, your card issuer will likely raise your limit. Your goal is to keep your balance to credit limit ratio low. You do want to use your credit cards on a regular basis. If you never use your cards, then your issuer may eventually cancel them.
If you do have credit card debt, you need to do two things before you can begin to fix your credit rating. First, you need to pay down the balance as quickly as possible so you can stop paying those high interest rates (pay off the card with the highest interest rate first). There are lots of great articles online about how to do this. Second, stop adding to your balance. If at all possible, stick to using cash until your credit cards are paid off. Once you have eliminated that debt, then you can work on building your credit rating responsibly. Although it’s nice to have a low interest rate on your cards in case of an emergency, technically the interest rate should be unimportant because you should be paying off your balance every month.
As long as you use them responsibly, credit cards should be a part of your financial plan. They don’t belong in your freezer.