6.11.2017

How to use a credit card: Part 3.

In the last post I went through the basics of credit. It was in no way comprehensive but I tried to touch on the things someone most needs to know in order to manage their credit score and understand how it's created and maintained. In this post, I'll get to the point of all this: how to use a credit card.

Let's start with three popular reasons someone might obtain a credit card.

1. To ease the cost of day-to-day living. This is, in my opinion, the most common reason people apply for cards. And with our mediocre dedication to the financial education of youth, it's also how we think of credit cards when we're just starting out on our own: supplementing the cash we have (or, in the case of many students, don't have). If it's true that fully half of Americans could not come up with $400 in an emergency, then it's easy to see the void credit fills when there's so much uncertainty piled on top of bills, childcare expenses, student loans, groceries, transportation, and the tiny bit you might set aside to do something nice, just to to feel human.

2. To build good credit. This is popular too, and has become more so over the last decade as sites like CreditKarma allow people to see an approximation of their credit scores and track how their decisions affect them for good or ill. Read reviews of secured cards on any website and you'll hear the same story over and over: "I needed to rebuild my credit after bankruptcy/a divorce/an expensive hospital stay/defaulting on my student loans," etc. etc. etc. etc. Because credit card companies report to the credit bureaus each month, it is an incredible opportunity to increase your credit score as time goes on. When factors like number of open accounts, credit utilization, payment history, and average age of accounts are so important, even using just one card responsibly can really have an amazing impact.

3. To reap rewards. You may have seen articles every now and then about how one crazy guy has 98 credit cards and uses them to fly all over the world and stay in luxury hotels, all for free. I hate those articles. But they illustrate the fact that you can make rewards credit cards work for you. You don't have to be nuts, or have half a dozen of them. If you enjoy analyzing the impact of your spending on miles or points accrual, and especially if you enjoy planning vacations and compiling information to get the best rates, then rewards cards are a no-brainer. But it's not just about travel - cash back cards can be pretty great too, especially if you have better-than-average credit.

Credit cards are also useful when renting cars and booking hotel rooms, as the use of a debit card usually requires several extra steps like employment and housing verification. Rental car companies in particular will put a hold on the card for a certain amount (in the low hundreds of dollars) while you rent, and it's hard to have a good vacation if your debit card is missing a chunk of change.



When you understand why you're applying for a credit card, you can choose a better card and have a plan for using it going forward. The last post touched on how to apply for a card armed with the knowledge you need; let's assume you have been approved for a card and are ready to begin using it. Here are some top things to keep in mind:

Aim for the 30% utilization ratio. This may be becoming more common knowledge thanks to the internet, but it also was a "rule" I didn't hear of until after I'd gotten my current card. You see, when you receive a credit limit, let's say $3,000, it seems rational to believe that the lender is saying, "Here's $3,000. Don't go over the limit." Unfortunately no. In order to maintain a beneficial credit score, you need to only go so far as 30% of your total limit. This is yet another reason having great credit is so important - you can get higher credit limits, which in turn means being able to charge more before hitting that 30% bar.

If you're in the rebuilding phase of your credit life, be prepared to start small. Know going in that this is not the time to go buying things you couldn't before. It's the opportunity to make on-time payments and gradually increase your limit, thereby increasing your credit score and giving you more latitude and opportunity. It takes time, and patience, and responsibility. But you can do it.

Don't miss a payment. If your personal situation is such that you will at some point need to decide between which bills to pay, do not get a credit card. If you are absent-minded and always forget to pay at least a couple of bills a year, do not get a credit card. If you think the world owes you something and get upset when lenders expect payment, do not get a credit card, but do get your life.

Pay more than the minimum, every time. How I got myself in trouble the last go around was never paying so much as a nickel above the minimum required each month. Ever. This meant my balance kept rising over time, and eventually the minimum was such that I couldn't feasibly pay more if I wanted to. Don't fall into this trap. If you're going to have a credit card, you must go in prepared to pay at least double the minimum.

Even though this is not tracked on your credit report, guess what? The card companies actually are watching this one, and it can determine whether or not you are approved for a credit limit increase down the line, and even factor in to whether they approve you for another card if you so apply.

Better yet - pay the statement balance in full. This is something you hear (or, read) a lot of people say when you google all things credit related. "I always pay my balance in full..." That sounds very noble, but why the heck would anyone do that? Isn't the point of credit cards to buy now, and pay over time? Well...not really.

There are, of course, several reasons people get credit cards, and in a perfect world, there would only be one reason: to work toward an excellent credit score. I've not stood on this soapbox because it assumes that everyone is capable of perfectly managing their money and all their lines of credit, when the reality is much bleaker. To acknowledge this is not to enable poor financial decisions, but rather to accept that people are human, they make mistakes, and also bad things happen. So what I would say is: strive toward the goal of paying off your statement balance each month, but don't beat yourself up if you fall short.

And guess what? You do get rewarded for being noble. If you pay your statement balance in full, the card company waives the interest fee. As explained before, interest accrues daily via the Average Daily Balance, but it magically goes away when you don't carry a balance. Notice that I keep saying statement balance, so not your current one - just what appears on your statement. (For more info on that, see here)

But let's say you're still not convinced. "Hey, I don't care about a measly $15 or $20 in interest a month." That's cool. Neither do I. But two things: 1) The higher your balance, the more interest you pay, so stay vigilant. An $80 interest payment sucks. 2) If you find yourself with a rewards card, that interest ultimately nullifies whatever you've earned. Those become just empty numbers. So if you're going to chase free vacations or statement credits, ya gotta bite the bullet and pony up.

(If you'll recall, in part 1 I said that lenders can't make money by breaking even - loaning out ten bucks and getting ten back. So why would they waive the interest for noble behavior? It's very simple. Most people carry a balance, and most people always will)

A good rule of thumb is to only charge what you have in the bank; that way you can easily pay off the statement balance each month. It also assumes, not to beat a dead horse, that you have not obtained a credit card to rack up charges with the idea that somehow one day you'll still come out on top.

Use the average daily balance to your advantage. You don't have to (and shouldn't) wait till the payment date to pay your bill. With most cards you can pay any time and as often as you want. Paying early in the statement cycle means that for the majority of the month, your balance is lower and accrues less interest than if you had waited and sat on a larger (and maybe rising) balance. Just a little tip for the penny pinchers out there (and those who are carrying a balance).

Use credit limit increases to your benefit. While they may taste as sweet as manna from heaven, there's only one good reason to request a increase, and that is to lower your credit utilization. If you have a $1,000 limit and you've spent $700, that 70% utilization is really dragging your score down. But if you can get your limit raised to $2,000 - you're instantly down to 35%, and you can pay down to get below 30%.

Most card companies will evaluate your account at set intervals, such as every six months, and grant you an increase if you qualify. If you haven't received one in a while, it may be due to your utilization, in which case you may still call and request one, or you can commit to paying down for a period of time, and then trying again.

Don't apply for multiple cards. I have been traumatized by the things I've read during my journey to understand credit. I love to read reviews of things, and there is no end to reviews of credit cards. Someone will write up a nice, cogent, rational paragraph and then end it with "I also applied for the Chase Freedom, the Amex Everyday, and the Capital One Venture, and plan on trying for a few more..." What?!?!

I am only me, so I can't say for sure why anyone would apply for multiple cards, like some kind of credit spree, but it is a terrible idea. You get a hard inquiry for every credit application, which immediately shows on your credit reports, which are pulled by each company as you keep applying, and all it tells them is: "this person is desperate for credit. Something must be wrong - they're clearly a credit risk." Don't willfully taint yourself and take yourself out of the game. It doesn't matter what uncle told you it was okay, or that your coworker applied for two cards in the same day and got approved for both; it doesn't matter that some weirdo manages 98 travel cards. Some life advice: you are the rule, not the exception. That may sound tough, but I've been plenty lenient elsewhere.

Also, the more lines of credit you have, the more payments you have to make. And there's no quicker way to fall into the hole of minimum payments (and eventually missed payments) than to have multiple credit cards. The same deep urge that gets you in this mess will be the same one that kept you from patiently analyzing your personal budget and realizing that this isn't the way to go.

Don't close the credit card. It may be that you're finally coasting with that 800 credit score and life is good, and that rebuilder card you got eons ago with the $750 limit is ready for bed. Wait. There are at least three credit score factors this effects: the average age of accounts, total number of accounts, and utilization. The higher the number the better for the first two. Especially don't close the account if it's your oldest one. Yes, it's annoying to have to hold on to a relic, but that's the credit game. Welcome to America. *sigh*

Additionally, your utilization ratio factors in all of your revolving credit, so while the $750 may seem piddly, it counts.

(Aside: how can I speak against owning multiple cards, and also promote scenarios in which someone may have multiple cards? It's because I'm against going on a credit spree, not building up your credit portfolio over a number of years. I'm assuming that you'll start slow and responsibly, and you will, won't you??)

Also don't let cards sit dormant for 12 months. It's almost funny how angry some people get, pecking out bad reviews for credit card companies, when knowing the basic rules would have saved them some time. A lender will close an account that hasn't been used for twelve months. An easy way to avoid this is to set up a recurring charge, like your Netflix bill, and then set up automatic payments to pay it off. You never even have to think about it, and your account stays open - and your credit score doesn't suffer.

There are going to be credit accounts that have to close, like when you pay off a student loan, a car note, a mortgage, or installment loan. You can refinance certain loans to keep them alive (which sounds tiring even to me), but you're going to take that hit eventually. Minimize the damage by carefully selecting the right credit card for you, knowing that you will be besties for a long time.

When you think you want a second card, take your time. Have you properly managed one card for an extended period - at least two years? All payments made on time, and paying at least double the minimum or the full statement balance? Have you watched your credit score markedly improve? Then that little credit itch you feel may, may just deserve to be scratched.

Don't just randomly open another card account though; there needs to be a purpose, and you can make this work to your benefit. Say your current card is no-frills. Think about applying for a cash back card, or one that racks up points for hotel stays. Make your decision make sense.

What if your circumstances have changed, though? You pay on time, your score's gone up, but you're carrying a balance month to month over the 30% marker, and there are storm clouds on the horizon of life. A second card would give you peace of mind...wouldn't it? Only you can say if it's something you should do, but the conventional wisdom is that if you need a second credit card, that's the wrong time to apply for one. Adding a new line of credit may help you pay for what you need short term, but all debts eventually come due; analyze how a second credit card payment will affect your finances, and figure out how much you can afford first.

***

Using a credit card can be as easy as riding a bike. The rules are actually fairly simple, but they are not quite yet common knowledge, while myths about credit cards still abound. If you have the desire to straighten up and fly right, or maybe you're young enough that you hope to sidestep most mistakes completely, it is entirely possible - but you must learn, learn, learn; you must be patient; you must hold yourself accountable; and NEVER think of credit as easy money or an in to a different lifestyle. Because trust me - creditors don't.

I hope this series has been educational, and helps at least one person. There is so much more that can be written on the subject, so I may revisit it in the future. In the meantime - careful spending. ;)

No comments: