Credit Cards - Part Two

Credit Cards Are a Handy Financial Tool If Used Wisely

Read part one of Credit Cards.

Credit Pitfalls

Credit cards are not bad things in and of themselves, but can become bad things very quickly. You can charge just about anything and get to pay for it about a month later. You can take part in the many rewards programs and get points for things you would have bought anyway, like food or gasoline. This is all great if you pay off the bill every month.

If you can afford it, why not. You're beating the banks at their own game.

The Cost of Credit Cards

The problem is that if you run up your credit card debt, but only make the minimum payment, that $300 TV you got on sale will really cost well over $1000. It can take 10 or more years to pay off a $5000 debt if you only pay the minimum each month. If you ask someone if he wants to be paying for a tank of gas tank years after it's been burned up, they will look at you like you're nuts, but that's exactly what happens to most credit card users that carry a balance.

If you read your monthly statements closely, you will see that the monthly minimum payment is barely enough to cover your interest due for that month. You are not making any dent in the amount you owe. Even now that the government is trying to raise minimums and require full disclosure, credit card debt takes years to repay.

So probably the best solution is to stay away from credit cards. But that probably is also not a realistic solution for most people.

Managing Credit Card Debt

The only realistic solution is to charge only what you can pay off quickly. The next best choice is to pay as much more over the minimum payment due as you can afford. Or consolidate your credit card debt into a lower interest loan or line of credit, but only if you destroy all your cards, close the accounts and do not apply for new ones.

Too many people who go the debt consolidation route soon find themselves with their cards maxed out again, but now with the bonus of a second mortgage. Their situation just goes from bad to worse.

Bad News

Many credit card companies now employ the "universal default clause". They check your credit report frequently, sometimes every month. Even if you are never late in your payments to them, they may decide you are no longer a prime customer and may raise your rate.

Some of the things the banks are looking at is your use of your overall debt – if your ratio gets too high they get scared. Another event that may trigger a rate increase is a late payment to another credit card company or even to the phone or electric company.

Being even one day late with a payment to any creditor may trigger up to a four times increase in your interest rate. If you’re using one of the free or very low interest offers banks use to lure you to them, they will likely hike your rate as high as 29%.

[Note that usury laws usually don't apply to credit card issuers. They have moved their operations to states that allow very high rates and the US Supreme Court has ruled that the laws of the state the lender is in controls how high your rates can go.]

Do not ignore the little messages the banks send you either in your statement or separately. They may contain nasty surprises, like an increase in your interest rate that you can avoid by simply writing the credit card company and no longer using their card. Read Know Your Credit Card Rights for more information.

Use Credit Wisely

Now more than ever, you must learn to use credit responsibly. The quick escape of bankruptcy has become a lttle harder to come by and it is just too costly over the long term to ruin your credit rating at any point in your life.

A bad credit score not only affects the interest rate you will pay on credit cards, personal loans and mortgages, but also may affect your ability to get a job, rent an apartment or result in an increase in your auto insurance premiums.

So take those little pieces of plastic seriously and handle them wisely. A line of credit does not make you any wealthier - the opposite is in fact true.

If individuals used the double entry accounting system used by most businesses, the would have to offset their use of credit against their assets. This would give them a truer picture of what the use of credit is doing to their personal bottom line.

Credit really should not be used to purchase "things" that don't add to your wealth - like a mortgage would. If you can't pay for your purchases within the grace period, you should not use them.

Of course, banks like it the other way around. So it's your choice. Just remember this choice has consequences.

[Consumer friendly changes are coming to credit card terms, but not until July 2010. Read about them in this article.]

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