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This week, MikedUp Blog is attempting to answer the question, “What are personal finance bloggers collectively wrong about?” My contribution is below, while Dan from Pennies and Dollars will provide his take on Thursday. Here’s a link to the intro post (from Monday) if you’re looking for more details. And as always, thanks for reading!
Dave Ramsey recently tweeted, “The credit card is the cigarette of the financial world. When we look back in the years to come we will shake our heads at the stupidity.” Additionally, some PF (personal finance) bloggers have written recently, echoing the “cut up the cards” sentiment.
You should also know that the current interest rate for credit cards is 15.07% – and that’s if you have good credit. The bad credit rate: 22.73%.
As an example, if you buy a $1,000 couch using a store credit card via payments for 60 months (5 years), you can expect to pay $429.60 in interest over the 5-year loan (this assumes the lower 15.07% rate). Sure, the $23.83 monthly payment doesn’t seem bad, but how about paying $1,429.60 for a $1k couch?? That sounds terrible to me.
To be fair, many have also hammered the counter-point
The other camp cites metrics like credit utilization ratio, credit score, and good ‘ole rewards points for reasons to keep the scissors away from the plastic.
I’ll tip my hand and admit that I’ve written a post that mentions how we earned $850 in cash back rewards in 2015! That’s real money that wouldn’t have been available to us if we hadn’t put our cards to work. But these perks can come at a great cost…
“With great opportunity comes great responsibility,” and credit cards are no different. In fact, credit card debt is one of the top 3 reasons people resort to bankruptcy. It is for this incredible risk that many highly successful people in the financial industry would tell you to stay far away. They argue that there is too much downside, you take on debt that you don’t need, and you basically can’t trust yourself with managing one. I’ve read their books and actually agree with a lot of what they say. Some of them have even helped me get to where I am today. But when it comes to credit cards, I couldn’t disagree more.
I argue that credit cards can be a tremendous tool in the hands of a responsible person.
First of all, there will come a time in most peoples’ lives when you’d like to buy a car, house, or another expensive object that you don’t have the cash to pay for up front. When that happens you’ll have to apply for a loan, and they don’t just hand those out nowadays. They’re going to have to vet your ability to make good on the payments in order for them to feel confident in lending you the money. One of the first and most important things a lender will check is your credit history. This is the point where not having any credit can be a huge drawback. If you use credit cards as a productive tool, then that’s not you.
Other benefits to having a good credit score because of your credit card include: rewards points, lower interest rates for loans (you can save tens of thousands of dollars with just 1% lower interest rate over the course of a $150,000 – $200,000 mortgage), lower security deposits when renting an apartment or home, lower auto or homeowners insurance rates, and security of transactions (credit card companies can intervene on your behalf in the case of fraudulent charges or purchases made with stolen cards). If those aren’t incentive enough, your ability to earn an income can be drastically affected by your credit score. One tactic many employers use is a credit check. They want to see how you handle your own finances before they put you in charge of some aspect of theirs. Poor credit could prove the difference between landing and not landing that dream job.
Another thing to keep in mind is that zero credit does not equal good credit.
In fact, no credit shows no history of you making payments on time, paying down loans, or being responsible with your debt. This is a detriment rather than a benefit when it comes to applying for a loan. The absence of a credit score does not allow a loan provider to evaluate your ability to pay them back.
What not to do – don’t put anything on your card that you don’t already have the money for
If you don’t have the cash already in your checking account, mattress, or freezer, don’t make the purchase. Gambling with someone else’s money is not a practice you should employ regularly. Just because you expect a certain amount of cash to come in next month does not make it so. People get laid off, sales dip, and believe it or not you can’t trust everyone. If you only purchase items on your credit card with cash you already have, you build credit, receive points, and avoid debt. Everyone wins… well, you win.
Credit card good practices
Maxing out your cards each month (even if you pay them off every month) is not helpful. This is called bad credit utilization and It shows you borrow perhaps more than you should. 20% or lower is the sweet spot, so keep it simple. That means $200 per month on a $1000 credit limit.
When you get your bill – pay it in full. You already have the money for it in the bank so make it happen. If you pay the bill before your due date you’re showing good credit history and avoiding those ridiculous interest rates that put good people under water. 30.00% APR only applies to remaining balance that is not paid in full at the end of the month. Because we don’t get to that point, the interest rate doesn’t matter.
Want to take it a step further? I pay our credit cards off every Friday. This gives me a better idea of what we are spending money on and allows me to track progress from week-to-week. I got the idea from Jon and Heather, who used it in their quest to pay off $89,000 in 15 months. Confirmed – effective.
Sure, a high-limit credit card can spell disaster in the hands of a person that doesn’t have their finances together, or in the hands of a person that is suddenly thrust into tough times. However, if you track your spending, only buy things you already have the money for, practice good credit utilization, and pay your bill in full every month Friday, then just sit back and decide how you’ll use those rewards points at the end of the year… My vote – beach.
Thanks for reading!
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