Debunking Credit Myths: Are Cards a Surefire Way to Get Into Debt?
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We discuss travel rewards credit cards quite frequently here at TPG. These cards allow you to earn top sign-up bonuses and then give you numerous bonus categories for everyday spending, opening up fantastic redemptions like premium-class flights and luxurious hotel rooms. However, there are a number of misconceptions out there when it comes to credit cards, so today I’ll continue our new series that debunks these myths and allows you to begin planning for your next vacation.
Previous entries includes having too many cards, closing a card you don’t use, how permanent of an impact an application has on your score, not paying your balance in full, paying an annual fee, keeping your points when canceling a card, whether annual fees count toward a sign-up bonus and what to do if your application isn’t immediately approved. Today I’ll shift gears and consider a myth that prevents many people from even signing up for a card at all.
Myth #9: Opening a credit card is a surefire way to get into debt.
Every time I apply (and am approved) for a new credit card, I’m always a little surprised at the amount of new credit that an issuer extends to me. If I add up all of my credit lines on the various cards in my wallet, my available credit is higher than my annual income. I could max out my cards this weekend and be in big trouble, but even if you have a single card, a credit limit of $20,000 (for example) can be a dangerous thing. You probably know at least one friend or family member who has overspent on a credit card and is now paying down a balance with hefty interest charges.
While our site devotes a lot of time to the rewards you can earn on top credit cards, it’s important to note that credit card issuers are not in business to give things to consumers for free. They make money in two key ways: transaction fees and interest/late charges. Neither of these are possible if you don’t actually use your card on everyday purchases. If an issuer only extended you a credit line that represented what you could actually afford each month, that wouldn’t be an enticement to use the card and would likely wipe out the chance of collecting interest entirely. By giving you greater spending power (and dangling carrots like introductory 0% APR), issuers are hoping you’ll use the card more and increase the fees they can collect.
However, this should not deter you from applying for a card. Opening and using a travel rewards credit card is not a guarantee that you’ll get yourself into debt. It all comes down to spending within your means. Remember that the very first commandment for travel rewards credit cards is to pay your balance in full every month. Even a single month’s worth of interest charges can eliminate any value you’d get from the points or miles you’d earn, and not paying the full statement balance can significantly impact your credit score as well.
This goes beyond just rewards as well. Many people may stay away from credit cards due to the fear of getting into debt, preferring payment methods like debit cards or cash, where there’s little to no risk of spending beyond what you can afford. However, using a credit card responsibly is an important way to build up your credit history. If you’ve never had a credit card, it’ll be much harder (or more expensive) to get a car loan or mortgage. On the surface, this seems like a paradox: If you stay away from credit cards to avoid debt, you’re responsibly managing your finances and should seemingly be rewarded for this conservative behavior. However, that’s not how banks operate. If you don’t have a lengthy credit history, it could hurt you when it comes to other financial decisions.
Note that you can start building up your credit history by becoming an authorized user on someone else’s account, which is something my parents did when I was in high school and it paid enormous dividends when I joined the working world and had several years’ worth of positive credit history. American Express even allows you to set customized limits for your authorized users online:
This can be a great way to ensure that a family member on your account can build up his/her credit history without too much risk to your credit score.
Opening your first credit card can be a scary proposition. Gaining access to a credit line that goes beyond what you can reasonably afford does carry some risk, but it can also be a key element in building up your credit history. The most important thing you can do is treat a credit card like a debit card and only spend within your means. This will not only help your credit score but will ensure that you develop the financial discipline needed for a successful future.
What are your thoughts on credit cards and their debt creation potential?