4 Credit Card Misunderstandings

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For many, a Credit card can be a confusing little plastic card to have. Depending who you ask, some will make you believe having one makes you a rich person with free money – Do not fall for it. If used properly, it can make your financial life look like you’re a rich person in many eyes. However, without discipline you may easily fall for these following misconceptions.

A Credit Card is needed:

TO BUILD CREDIT

You do not need to have a credit card to build credit. There are many ways you can start building credit without ever owning one of these plastic cards. If you consider yourself a responsible person when it comes to money like making payments on time and keeping your debt-to-credit ratio below the recommended amount (30% and less), you should be able to qualify for any credit cards and loans out there. 

Being An Authorized User On A Good Standing Credit Card User

An authorized user can be a great way to build credit as long as the cardholder and yourself use it responsibly. It also can be beneficial to the primary cardholder if they want to earn reward points, if applicable, or keep an account active, if only if the company reports your history activity to the credit bureau. 

Few things to remember as an authorized user:

All responsibilities will fall on the primary cardholder.
The activities history will be part of the cardholder statement.
Any rewards earned will be added to the primary cardholder account.

FOR EMERGENCIES

For many, having a credit card seems like the ideal way to pay for unexpected days like a car repairs or the house oil heater stopped working the moment it was needed the most. Yes, it sounds great to simply swap the plastic card and worry about it when the monthly bill is due. This is a terrible financial move.

Every time you swap that flat-plastic-card, the bank automatically assumes you’re out of cash therefore you need a small loan. The only time to prove them wrong is only if the bill is paid in full. Remember, If you’re not borrowing money to make more money in the long term, every loan taken is nothing but debt accumulation.

If you have a good credit score, it’s best to look for affordable alternatives to pay for these sorts of problems. For instance, some banks personal loans fixed-rates are as low as 6% APR. Also, there are many peer-to-peer, aka P2P, lending companies with loan rates as low as 4.49%. P2P are made of a group of investors willing to accept borrowers with lower credit scores unlike the banks. But with a higher fee of course. Last but not least, asking family members will always be better than paying an 18-plus % APR credit card loan. It’s best to do your homework and see which alternative is best for your needs and which you’ll be able to pay back in a timely manner.

FOR STORE DISCOUNTS

If you’re constantly shopping, spending lots of money in related stores that allow you to use reward points from that one credit card then it can be to your advantage. Study has shown, store credit cards APR  and balance fees are higher than traditional credit cards in the long run.

For example, spending $1000 to save 20% on your first purchase is $800. Paying it in full before accrued interest is a nice bargain. However, if you plan to pay the remaining balance monthly within two years at an average of 26% APR, you’ll need to pay $44 per month. The interest alone will be about $210 for the life of the debt – assuming there’s no fee on that particular card.

In such a case, you’re better off using other debit cards that offer reward points, like Chase Sapphire, Discover Bank Cashback or your traditional credit card at 18% APR, paying $50 per month and still saving in the long run.

The point here is to not carry any balance on these store credit cards. The same applies for any other credit cards unless you plan to pay it in full and avoid the high interest fees. Let’s not forget these card issuers earn a profit on the balance you carry.

CANCELING YOUR PAID OFF CARD CAN BOOST YOUR CREDIT

The only reason I can see canceling a credit card makes sense is only if you no longer want to keep paying an annual fee otherwise, it is not worth it. Let’s say before you decide to close the card, consider the impact it will have on your credit history and your credit availability. There are too many downsides when closing a credit card.

If you’re a new credit cardholder, it will be harder to qualify for another credit card, or any type of loans in that case since you have not built a credit history long enough. Even if you always pay the balance in full every month.

If you’ve been a cardholder for a long time, reducing your available credit while increasing your debt does no justice either. Especially, if you decide to close the card you had the longest. Your credit utilization ratio makes up 30% of your FICO credit score. When closing a card, you tend to increase the debt-to-ratio over your total credit availability. How? 

Here’s an example, let’s assume you have two credit cards, one with $15000 with a balance of $5750, the other $8000 with no balance. You’re using 25% of your total credit availability ($15000 + $8000 = $23000) – that’s your debt-to-ratio. Now, you canceled the card with no balance, your total credit is that one card of $15000 then your new debt-to-ratio is now 38.33% which surpasses the recommended FICO credit utilization. As a result, your credit score will decrease.

BOTTOM LINE

There is nothing wrong with having a credit card. I, personally,  encourage any responsible person to get one. But, be aware of the misinformation being spread about them. Do your due diligence and understand all the facts before canceling your credit cards.

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