I don’t know about you, but I use a credit card almost every day. I use it to buy books -- usually via bookfinder.com, the online price aggregator. I use it to pay my membership fees to the American Association of University Professors and other organizations. I use it to secure plane tickets for conferences. I use it to buy groceries and gas. I use it for just about every transaction imaginable. Greenbacks and coins are so 19th century, dude. Binary digits are the future.
Actually, like many cavalier dismissals of the past, that one is mistaken. The utopian novelist Edward Bellamy envisioned the use of cards in place of money as early as 1888 in his futuristic work Looking Backward. The brainchild of an imaginative socialist, credit cards would only be realized in the consumer capitalism of the 1970s and 1980s.
Credit cards are extremely convenient, but they contain the potential for disaster. I first heard the phrase “plastic magic” in 1988 or 1989 when I worked behind a bakery counter after graduating from college. As he snatched a card from a customer, a waiter flirtatiously called out that phrase. Even then, the words struck me as wish-fulfillment. Now I find “plastic magic” to encapsulate perfectly the financial abandon of the Reagan era and the two decades that followed.
When news broke this summer of Michael Jackson’s death, my first memories were of being 7 years old and hearing the sweet sounds of the Jackson 5’s “ABC” while riding my bike around our cul-de-sac. But the news media’s fixation on Thriller, an album I never liked, has brought home to me Jackson’s dual 1980s status as pop icon and profligate. Just as Michael Jackson refused to grow up in the 80s, escaping into an absurd and expensive Neverland, so did America indulge in extravagant fantasy. Consumer debt more than doubled between 1980 and 1987, mostly on credit cards. Corporate and government debt ballooned, too. Within a decade, America went from being the world’s largest creditor nation to its largest debtor nation. Michael Jackson’s sad demise comes in the midst of a Great Recession delivering a punishing payback for decades of excess borrowing, with reports that he himself left behind $500-million in debt. Beat it!
There is no such thing as plastic magic. The bill always comes due, whether for pop singers, nations, or professors. Nevertheless, used wisely, credit can be a valuable financial tool.
Here I unveil Pennywise’s six most important things to know to take advantage of credit cards while avoiding their perils.
First, know how credit cards work. A credit card is a medium of exchange backed by the willingness of the card issuer —typically a bank, such as Citibank, Chase, or Capital One —to extend a loan to you. Every time you charge a new amount over a network like Visa or MasterCard, you increase what you owe to the issuer.
Credit cards are remarkably flexible. You may use none, some, or a great deal of your credit in any given month, capped at a pre-approved limit. Amazingly, no interest is charged during the grace period. How many other ways do you know to use someone else’s money interest-free for 30 days to buy anything you wish? It is an extraordinary deal —not a bad approximation of Edward Bellamy’s utopia.
Second, know thyself. Credit cards are not for everyone. The most important principle of personal finance is living within your means. Some people feel no restraint when in possession of a credit card. If credit cards seduce you to spend a lot more than you can pay back, then don’t use them. Cut them up. Pay by cash or check. Get a debit card —similar to a credit card but deducted from your bank account —to use in such situations as renting a car.
There are four types of people when it comes to credit cards. The first kind never uses them, whether by choice or necessity. The second uses them but pays off the balance every month. The third carries a balance and merely pays the minimum every month. The last pays irregularly, ending in delinquency and default. Which of these methods is best?
We can rule out delinquency and default —they are obviously catastrophic —but some may be surprised to know that to carry a balance is equally inadvisable. Banks charge outlandishly high rates of interest on accrued credit-card debt. Just as pushers make their best money off serious addicts, cardholders with revolving debt are the ones banks drool over. An associate dean once let slide in conversation with me that he hates it when he reaches his cards’ limits. Why, I wondered, would someone at the income level of a dean max out their cards, triggering astronomically high rates of interest?
A halo of virtue may encircle the heads of those who never use credit cards, but the shrewdest approach is actually to use cards and pay them off completely every month. Why? Because credit-card usage establishes a sound credit history. That can be useful for a host of reasons, such as reducing the price of your insurance premiums. Make it a rewards card, and you’ll get a cherry and whipped cream on top.
Third, know your card’s terms. What is the interest rate? Is it fixed? What is the fee for late payment? Is there an annual fee? Are there rewards? Pennywise advises that you never pay an annual fee, hold only rewards-generating cards, and strive never to carry a balance, if possible. Don’t view card terms as written in stone, though. Call to request a waiver of the late penalty if you mostly pay on time but accidentally miss a deadline one month. Ask for an interest-rate reduction, too.
Fourth, know the scams. Never use the “checks” that card issuers send out. Those function like cash advances, entailing exorbitant rates and fees. They are also a temptation to identity thieves. Call the 1-800 number on the back of your card right now and tell your card issuer never to send you checks and to take you off all promotional mail lists.
Fifth, know the ratings system. Big Brother is watching you. Card issuers share data with three agencies: TransUnion, Experian, and Equifax. They monitor your card usage, regularity of payment, credit limits, balances, and duration of history. They supply that information to anyone, from landlords to potential employers, willing to pay for it.
It is definitely in your interest to preserve a good credit rating. Under federal law, you are entitled to one free credit report from each agency each year (easily done at http://annualcreditreport.com). Make it a practice to check your reports periodically for errors, but don’t sign up for the expensive, needless “monitoring” that such sites offer.
It is not hard to boost your credit score. Always pay the required minimum. Leave most of your credit limit untapped. Hold cards for a long time and use them; it shows you are responsible. Increase your ratio of credit to debt, both by paring down debt and requesting higher credit limits. Request a limit increase even if you never mean to use it. Just don’t request it shortly before applying for a mortgage or some other big loan, because then it might appear you are in danger of getting in over your head.
One last point: Holding an auto loan, student loan, or mortgage in addition to a credit card demonstrates you can handle multiple lines of credit.
Sixth, know the alternatives. Bankrate.com and creditcards.com are both excellent Web sites for shopping around for a new card. If you carry balances, look for one with a low fixed interest rate. If you carry no balance, hunt for rewards cards that provide free air miles, hotel stays, or cash back on some or all of your purchases. Compare terms: Some cards are far more advantageous than others.
Ideally, secure a no-annual-fee card that boasts ample rewards, don’t spend beyond your means, and pay off your balance —or at least the minimum —each and every month. Used in that fashion, your card will facilitate transactions and provide bonus benefits without leading you down a sequin-gloved path to millions of dollars in debt. It’s as simple as A-B-C, one-two-three.
