Credit cards can be a good friend or a terrible enemy depending on how you use them. If you use your credit cards sensibly they can be an easier way to pay for things than carrying a big wad of cash. If you need to make a major purchase and don’t have the money in your checking account to cover its costs you could use a credit card to pay for it. Most of today’s credit cards come with some nice perks such as cash back, points and airline miles. If you lose your job or run into some other emergency your credit cards could bail you out until you’re back on your feet. And last but certainly not least credit cards can help you track your spending, which can be very important if you’re trying to stay within a budget. But credit cards can also encourage you to spend more money than you have, which means creating debts that you may have a very difficult time paying back. There are also some other things about credit cards you need to know and hear are eight of the most frequently asked questions about them.
Q. Why is it so important that I pay off my balances at the end of every month?
The answer to this has to do with a thing called compounding interest, which some people have called one of the most powerful forces on earth. It can hurt you when you carry balances forward because you’ll basically be paying interest on interest. As an example of this if you were to have a $10,000 balance on a credit card that has a 14% interest rate that’s compounded monthly your finance charge or interest the first month alone would be $116.67. If you were to then make just a $200 minimum payment only $83. 33 would be applied to the principle. The next month your balance would be $9916.67 but only $82.64 of your minimum payment would go towards the principal. At this rate it would take you more than 36 years to pay off your original balance assuming you made no more charges on the card.
Q. Is it a good idea to close any credit cards I’m longer using?
The answer to this one is a simple, “no.” The reason for this is that 30% of your credit score is based on your credit utilization ratio. It’s calculated by dividing your total credit card limits by the amount you’ve used. Let’s suppose you have $10,000 in total credit card limits and have used or charged $5000. In this case your credit utilization ratio would be 50%, which would be too high. Ideally you should keep that ratio below 30%. If you did have $10,000 in total credit available and had used $3000 of it your credit utilization ratio would be 10%. But if you are to close two cards so that your total amount of credit available dropped to $7000, your credit utilization ratio would immediately go to 42% and this would have a negative impact on your credit score.
Q. Why is it important that I read and understand my credit card agreements?
Your credit card agreements are contracts that spell out what you are expected to do. As a general rule they include fees for late payments or if you go over your limit. It’s important to know what these are because if you’re not careful they can begin to really pile up, which means you’ll just be adding on more debt. It’s especially important to read the agreements that come with rewards cards so you will know exactly how much cash back, points or miles you’ll earn depending on what you do. You could also find there are fees that will be tacked on if you use that card outside the US. It’s important to carefully read all of your credit card agreements including the fine print so you’ll know how to use that card wisely.
Q, Is it okay to use a credit card to get a cash advance?
No matter how tempting it might be to use one of your credit cards to get a cash advance the answer to this is just say no to yourself. We don’t know of a single credit card where the interest charges aren’t a great deal higher when you use it to get a cash advance. This is yet another reason to read your credit card agreements carefully. You may think you’re paying only a 14% APR but that’s probably just for purchases. The card’s interest rate could go as high as 19% or even 21% on cash advances. You might be thinking you’re paying only 14% when you take out a $500 advance but when your next statement rolls in you could be in for a nasty surprise.
Q. My spouse or parent died leaving a large amount of credit card debt. Do I have to pay this?
The answer is you probably will not be responsible for his or her debts unless you were a cosigner on the account. The exception to this is if you live in a community property state such as California, Nevada, New Mexico, Idaho or Texas. In this case any debts that were incurred during your marriage will be considered as community property and you’ll likely be responsible for them.
Unfortunately, there is no simple answer to this as there are other factors involved in making this decision. However, it’s important to understand what a bankruptcy will do to your financial life. For one thing, it could drop your credit score by as many as 200 points. It will stay in your credit reports for 10 years although the effect it has on your credit score will diminish as the years go by. More and more employers are checking credit reports as part of the employment process so bankruptcy could actually cost you a good job. You will have a hard time getting new credit for at least two years after bankruptcy and when you do it will be “low balance, high interest credit.”
Q. My child has a lot of credit card debt. What can I do to help?
Probably the best thing you could do is give him or her a lot of information about smart money management. But if you’re considering paying off that debt keep in mind that you may just enable more bad behavior. But if you just can’t resist doing this make the money a gift and not a loan. That way there won’t be any conflict in the future about getting paid back – or not being paid back. Alternately, you could agree to give your child the money but only if she or he would be willing to sign an official loan agreement. You might also ask your child to set up automatic transfers of the payments to your checking or savings accounts. That way there will be no question about whether or not a check was mailed.
Q. What is the ideal number of credit cards to carry?
As a general rule you should be okay with just two major credit cards. One of them should be a low interest rate card for those times when you must carry a balance forward. The other should be one with a grace period. Of course, the best card would be one where there is no annual fee and no interest for some period of time. If you’re concerned about your credit then two cards is a good number as well. However, it’s also a good idea to have at least four credit accounts of different types. This could be your mortgage, a car loan, a major credit card and a store card. Part of your credit score is based on the types of credit you have as this shows potential lenders that you can successfully manage different types of credit.
Finally, here is a short video, courtesty of National Debt Relief, with some good information on how to manage a credit card.