Are
credit cards good or bad? That’s like asking if fire is good or bad. If the
fire is keeping you warm and cooking your food, then fire is GREAT! But if it
is burning your house down ... well, maybe not so much. The same is true of
credit cards. If kept under control, there are many benefits to credit cards,
but if credit cards are controlling you, they will burn you alive.
The
costs of credit card use are well known because so many people have allowed
their credit cards to burn uncontrolled. They succumb to the 'minimum payment'
rouse and buy whatever their hearts desire and before they know it they are
thousands (sometimes tens of thousands) of dollars in debt. The once manageable
minimum payment has grown to be a serious burden and at high interest rates can
take decades to pay off.
However,
with careful and wise oversight (i.e. no gas poured on the flame) credit cards
can really be a great way to make purchases. The catch: YOU MUST PAY OFF THE
ENTIRE BALANCE EACH MONTH AND PAY IT ON TIME! If you don’t pay off the entire
balance you will be hit with high interest charges. Even if you pay off MOST of
the balance, credit card companies have this funky way of determining your
average balance (skewed heavily in their favor, of course) and will still
charge a lot of interest. If your payment arrives even a day after the due
date, you will be charged an atrocious late fee.
So
why bother with a credit card if you have to be so careful not to get
slaughtered by interest, fees and penalties? First of all, you can earn cash
back and other benefits such as free airline flights and roadside assistance.
Also, it is often the case that credit cards will insure goods purchased
against theft or malfunction (but you have to remember that you have this
insurance. My son had a portable hard drive stolen out of his backpack at the
airport -- we think a TSA employee slipped it into his pocket -- and we forgot
that the insurance provided by our credit card covered that. We eventually did
remember, but not until after the three month deadline had passed. These
benefits are not of much value if you forget that you have them). Credit cards
are also a great way to travel and to keep track of expenses. It is all right
there on the statement. And, of course they can be helpful in an emergency --
especially if you are away from home (some credit cards even offer concierge
services).
Why
do credit card companies provide all these kickbacks and where does the money
come from? The money comes from the stores where you make your credit card
purchases. They pay a fee to the credit card company to process the payment
(the reason some places do not accept American Express is because their fee is
higher than most other cards). When the credit card gives you your reward, they
are essentially sharing part of this fee with you.
Some
retailers charge a higher price if you use a credit card (I have seen this at gas
stations from time to time) to pass along this fee to the customer but this is
rare. Most of the time, credit card users pay the same price as those who pay
with cash. Given that this is the case, it makes sense to make all of your
purchases with a credit card so you can take a free flight now and then. BUT
AGAIN, ONLY IF YOU PAY OFF THE ENTIRE BALANCE AND PAY IT ON TIME! Otherwise
this will all backfire (that is, the flame becomes unmanageable and begins to
burn your house).
HOWEVER,
there is a very important downside to this strategy. With purchasing power
always so convenient, it is human nature to spend more with a credit card than
would have been spent with cash (or a check/debit card). Even with the
commitment to pay off the entire balance and pay on time, it is all too easy to
stop at a whim to buy that slice of pizza or tank of gas for a last minute trek
out of town. This is where you have to be careful to keep your spending under
control. It is in those weak moments that you can get into trouble where using
cash or check/debit card may not. So in addition to paying the entire balance
and paying on time, we need to add another requirement for making credit cards
work for you: NEVER BUY ANYTHING YOU WOULD NOT HAVE PURCHASED WITH CASH.
Credit
cards are especially hazardous for college students. Many students have gone
down in flames from excessive credit card debt, sometimes even having to drop
out of college. Again, BE CAREFUL. YOU ARE PLAYING WITH FIRE!
As
always, there are costs and benefits to everything. Like fire, credit cards can
be high risk. If you can’t handle them properly, don’t use them. (Psst, most
people can't handle them)
The
links below take you to a special section in Business Week magazine that talks
about credit card problems and shady marketing practices used by credit card
companies to get college students hooked. This is fire indeed!
MM
