If you ever want to start an argument in a financial forum, all you have to do is bring up the topic of credit cards. It seems that everyone either loves them or hates them.
Some financial gurus see credit cards as pure evil. In one Facebook post, Dave Ramsey says they’re like cigarettes: “Everyone knows it’s bad and will kill you, yet people still use it.”
But others, such as Jeffrey Strain of The Street, argue just as passionately in their favor. Strain calls credit cards “an excellent financial tool” because of their convenience and the protections they offer.
Credit Card Advantages and Disadvantages
|Convenience||Temptation to Overspend|
|Cash Back & Rewards||Interest Charges|
|Potential To Build a Good Credit Score||Fees|
|Cash Cushion||Fine Print|
|Theft Protection||Potential to Harm Your Credit Score|
Both fans and foes of credit cards have made up their minds, and nothing is likely to change them. But for those who are on the fence, it’s worth taking a closer look at the arguments on both sides — for credit card use and against it — to see just how well they hold water.
Advantages of Credit Cards
Even credit card lovers admit that it’s possible to use them unwisely. That’s why arguments in favor of credit card use almost always start with the words, “As long as you pay them off every month.”
For those who have the discipline to use their cards this way, supporters argue, paying with plastic makes a lot of sense.
For many people, the biggest advantage of credit cards is their convenience. Credit cards offer several benefits over cash, including:
- Fast Payment. It takes only a few seconds to swipe, tap, or insert your credit card at the checkout. That’s much faster than fumbling with bills and coins.
- Easy Access. When you shop with a credit card, you don’t have to worry about how much cash you have in your wallet. That’s especially handy in emergencies, such as being stuck at night in an unfamiliar city and not knowing where the nearest ATM is.
- Fewer Trips to the Bank. Paying with credit means you don’t need to hit the bank as often to pick up more cash. You also don’t need to carry around a big wad of cash that could make you a target for thieves.
- Currency Conversion. Credit cards are the easiest way to shop while traveling abroad. They automatically convert purchases in the local currency to dollars on your bill, often at a better rate of exchange than you could get from a bank.
- More Shopping Options. There’s no way to pay in cash when shopping online or over the phone. You can use debit cards or online payment apps at some retailers, but others don’t accept them.
- Deposits. Often, you need to provide a credit card number to reserve a hotel room, a rental car, or even a table for a large group at a restaurant. That protects the company by allowing it to charge a cancellation fee if you don’t show up. Some vendors don’t accept debit card deposits.
Of course, you can get most of these same benefits with a debit card. It works just like a credit card, except that the money comes directly out of your bank account. This prevents you from running up debt, but it’s also a drawback in some ways.
When you use debit, you have to keep a careful eye on your bank balance to avoid overdrawing your account. With a credit card, you get just one bill each month and make just one payment to cover it. That means less paperwork and less risk of making a math mistake that could lead to a costly overdraft fee.
It’s also harder to make reservations with a debit card. Hotels, car rentals, and cruise lines typically put a “hold” on your account when you make a reservation. With a credit card, this only reduces your available credit. But with a debit card, it ties up actual money in your account.
2. Cash Back & Rewards
When you pay for something with cash, that money is gone. But when you pay with a credit card, you can often get some of it back through a credit card rewards program. The three main types of reward programs are:
- Cash Back. The bank returns a percentage of the money you spend to you as a check or as a credit toward your bill. Many cash-back cards pay 1% on all your purchases, but some pay more for purchases in certain categories, such as gas or dining out.
- Travel Rewards. Some cards award you frequent flyer miles that you can save up for free or discounted airline tickets. In some cases, you can also cash in the miles from a travel rewards card for gift cards, merchandise, or cash.
- Points. The trickiest credit card programs offer “points” you can cash in for gift cards or merchandise. The cash value of the items you get with your points isn’t always stated, making it hard to figure out how much value you’re getting out of the program.
Credit cards can earn you hundreds of dollars in rewards each year. For instance, if you have a 1% cash-back card and you charge $2,000 to it each month, you earn $240 per year. If the card also offers 5% cash back on travel and dining, spending $3,000 in these categories tacks on an extra 4%, or $120.
Additionally, many credit cards offer lucrative sign-up bonuses. For instance, a card could give you 50,000 points for spending $3,000 within the first three months of card ownership. If you use your card a lot, this can be a good way to rack up rewards quickly.
However, no matter how good a rewards program is, it’s not a good deal if you carry a balance. There’s no benefit to earning 1% cash back if you’re also paying 17% interest on all your purchases.
3. Building a Good Credit Score
Credit cards are an important tool for building credit. Using a credit card regularly, and paying the bill on time, is one of the easiest ways to build your credit history and develop a good credit score.
This, in turn, makes lenders more eager to make loans to you. Having a good credit score helps you qualify for better interest rates on credit cards, auto loans, and home mortgage loans. By contrast, having no credit history can make it impossible to get a loan at all.
Some credit card haters argue that this shouldn’t matter. For instance, Dave Ramsey calls the credit score an “I-Love-Debt” score and says if you aren’t dependent on debt, you don’t need one. Even for a mortgage, he argues, it’s possible to rely on manual underwriting instead.
However, there are several problems with this argument. For one thing, most lenders only offer manual underwriting for certain types of borrowers, and many don’t offer it at all. It also takes more time and a lot more documentation to get a mortgage this way
Moreover, credit scores aren’t used only for lending decisions. In many states, a good credit score can save you money on auto insurance as well. Even landlords and potential employers may use your credit score to evaluate how trustworthy you are.
The bottom line is, it never hurts you to have a good credit score, and it often hurts to have none at all.
4. An Emergency Cash Cushion
Credit cards give you an extra cash cushion to fall back on in emergencies. If you run into an unexpected expense like a medical bill or a car repair, you can put it on the card and pay it off over time. And if it’s an expense you can’t put on the card, you can take a cash advance.
To credit card opponents, the ability to buy now and pay later is a bug, not a feature. Because of credit cards’ high interest rates, paying for your car repair over six months will cost a lot more than paying up front. It’s much better to have an emergency fund for this kind of expense rather than relying on credit.
All that is true, but there’s no reason you can’t do both. You can rely on your emergency fund for most unplanned expenses while keeping the credit card in reserve as a fail-safe. If you ever need extra cash in a hurry, your card will provide a quick and easy way to get it.
5. Theft Protection
If someone steals your wallet full of cash, the money is simply gone. By contrast, if someone steals your credit card and uses it to make purchases, you aren’t required to pay for them.
That protection applies to debit cards too, but there’s one key difference. By the time you discover your debit card is gone, any purchases the thief made with it have already come out of your bank account. You can report the theft, but you still have to wait to get your money back.
With a credit card, on the other hand, the thief’s purchases simply get added to your bill. Since you can report the theft before you actually get the bill, you never have to pay for the purchases you didn’t make.
Even if you fail to report a theft right away, your credit card still limits your liability. The most you ever have to pay for false charges made with a credit card is $50. If it’s only your credit card number that’s stolen, not the physical card itself, you don’t have to pay a single cent.
Debit cards also offer some fraud protection, but your liability is higher. If you don’t report the loss of the card within two business days, you’re on the hook for $500 rather than $50. And if you don’t report it within 60 days after getting your statement, you must pay all the charges.
6. Purchase Protection
Credit cards protect you against other forms of loss as well. For instance, if you order something online and you never receive it, you can formally dispute the charge with your credit card issuer. This is a time-consuming process that should only be a last resort after you’ve tried to rectify the situation with the merchant, but it’s nice to be able to fall back on it.
It’s possible to dispute charges on a debit card as well, but it’s harder. The money has already left your account, and you have to persuade the bank to return it. It could take up to 11 business days to get your money back.
On top of that, some credit cards offer additional perks that protect you if a purchase goes wrong. Many are free. They include:
- Purchase protection, which refunds your money if a brand-new purchase is lost, damaged, or stolen
- Price protection, which pays you the difference if you see the item you just bought on sale for a lower price (though credit card price protection is less common amid competition from online comparison shopping engines)
- Extended warranties, free of charge, for items such as electronics
- Mobile phone insurance, which protects you from theft or damage to your phone when you pay the bill with your credit card
- Roadside assistance, such as towing or jump-starting if you get stranded in your car (though you may still have to pay out of pocket for these services)
- Travel insurance, which helps cover the cost of emergency travel, medical bills in a foreign country, lost or damaged baggage, and costs if a trip is delayed or canceled
- Rental car insurance, which covers theft, damage, and towing charges when you book a rental car with the credit card and decline the rental car company’s insurance coverage
7. Expense Tracking
Making purchases with a credit card gives you a record of your spending. Your credit card bill lists all your purchases, so you know exactly where your money is going. This information is handy for creating a budget or for making sure you’re sticking to the one you already have.
By contrast, when you buy most things with cash, it’s easy to lose track. You can withdraw $60 on Monday, be down to $20 by Wednesday, and have no clear idea of where the other $40 went.
Of course, you could keep track of cash spending by saving receipts or writing a list of your purchases, but you have to remember to do it. With a credit card, record-keeping is automatic. You can even plug info from your credit card bill into a budgeting app to get an overview of your spending with minimal effort.
Disadvantages of Credit Cards
To many people, the convenience of credit cards is the very thing that makes them dangerous. This makes it very easy to get in over your head with credit card debt. And several other features of credit cards, such as their high interest rates, make it very difficult to get out again.
1. Temptation to Overspend
Credit cards make it easy to spend more money than you have. If you really want that new TV set or that fabulous cruise vacation, it’s easy to think you can just put it on the card and pay later. As long as you can manage the monthly payments, what does it matter?
But doing this is a good way to get trapped under a pile of debt. According to Lending Tree, more than half of all active credit card users carry a balance, and the average amount is over $6,500. That’s about 10% of what the average U.S. household earns in a whole year.
The good news is that nearly half of credit card users pay off their balance each month. However, even if they’re not spending more than they have, they could still be spending more than they should.
There’s some evidence that paying with plastic feels less real than paying with cash, making it easier to overspend. In a 2000 study at Massachusetts Institute of Technology (MIT), students who used a credit card made higher bids for sports tickets than those who had to pay in cash. Similarly, a 2008 study published by the American Psychological Association (APA) found that people set a higher budget for a Thanksgiving dinner when paying with credit.
Yet these studies also suggest there are ways to reduce the risk of overspending. When the MIT students bid on a $175 restaurant gift certificate, they bid about the same amount using cash or credit. Knowing the item’s exact dollar value made them less inclined to overbid.
Likewise, in the APA study, the gap in grocery budgets disappeared when participants had to estimate the price of each item separately and add them up. Thinking about the actual cost of each item they were buying made the money they were spending seem more real.
In short, the key to avoiding overspending appears to be mindfulness. If you look at prices and add them up in your head as you add items to your shopping cart, you’re less likely to pay a premium with plastic.
2. Interest Charges
If you carry a credit card balance, you have to pay interest — a lot of interest. In the U.S., typical annual percentage rates on credit cards in the U.S. range from around 15% to 25%.
Suppose you’re a typical credit card user with a balance of $6,500 and an 18% interest rate. If you make the minimum payment each month — typically around 2% of your total balance — it will take you over 30 years to pay it off. Over that period, you’ll pay more than $16,000 in interest — about two and a half times the original balance.
And that’s assuming you never buy anything new with the card over those 30 years. If you keep adding new charges while paying only the minimum, the balance might never get any lower at all.
Fortunately, most credit card users don’t do this. Only about one in four cardholders usually or always pay the minimum amount. If you pay a flat $400 per month toward your $6,500 balance, you can pay the whole thing off within two years and while paying just over $1,000 in interest.
Better still, you can avoid interest payments completely by paying your whole balance each month. As long as you pay the full amount listed on your bill before the due date, you don’t have to pay a dime in interest. Nearly half of credit card users do exactly that.
Interest payments aren’t the only cost of doing business with a credit card company. Credit cards also hit you with fees for just about everything you can think of. Types of fees include:
- Annual Fees. Some credit cards charge users a yearly fee just for using the card. You’re most likely to find this type of fee on cards with generous rewards programs. Users put up with the fee because they can earn more than its cost in rewards and other perks.
- Balance Transfer Fees. When you transfer a balance from one card to another, the new card charges a fee that’s typically 3% to 5%. This can be worth it if your new interest rate is much lower, since you could save more in interest than you spend on the fee.
- Cash Advance Fees. If you need cash in a hurry and your bank account is low, you can borrow some cash with your card. The fee for this is typically either 3% or 5% of the amount you borrow. Cash advances usually come with a higher interest rate and no grace period, so you owe interest before you even get your monthly bill.
- Foreign Transaction Fees. If you use your card in a foreign country, you could pay a fee of around 3%. However, there are some cards without foreign transaction fees that are handy for frequent travelers.
- Late Payment Fees. If you’re even a single day late paying your credit card bill, you can expect to be socked with a fee of up to $30. If you miss a second payment within six months, the fee can jump above $40.
- Over-Limit Fees. Normally, if you go over the credit limit on your card, the card issuer simply rejects any new charges. However, you can opt in to allow over-limit payments to go through. If you do, the issuer can charge you an over-limit fee of up to $35 each time.
4. Fine Print
In many cases, it’s possible to avoid fees by choosing your card wisely and sticking to the rules, such as paying your bills on time. However, credit card issuers are sneaky. Sometimes they try to tempt you into using your card in ways that incur a fee while hiding the cost in the fine print.
For instance, banks sometimes send you “convenience checks” that you can use like a personal check and have the payment charged to your credit card account. What they don’t usually mention is that payments made with these checks are treated like cash advances. The interest rate is higher, and there’s no grace period.
Balance transfer offers are another example. Banks often send you offers to move your balance to their card for a temptingly low rate. You have to read all the way down to the bottom to see the information about the balance transfer fee they charge for this service.
To avoid these sneaky fees, you have to read every bit of the text in your credit card application. However, banks don’t make this easy to do. Besides using tiny type, they often write the terms in financial jargon that’s hard for ordinary people to understand.
That’s why it’s a good idea to check professional credit card reviews before applying for a card. They sum up a card’s pros and cons in plain language, including interest rates, fees, and rewards.
5. Potential to Harm Your Credit Score
Using credit cards is a good way to build credit, but only if you use them wisely. If you run up a huge bill on your new credit card and pay only the minimum — or worse, miss a payment entirely — you’ll do your credit score more harm than good.
Ways a credit card can damage your credit score include:
- Late Payments. Missing a credit card payment is a big red flag for lenders. You’ll ding your credit score every time you fail to pay your bill by the due date, and even more if you pay more than 30 days late.
- High Credit Utilization. If you’re using too much credit, lenders see that as a sign that you’re overextended. Ideally, you should use no more than 30% of your available credit. For example, if your credit limit is $5,000, aim to keep the balance below $1,500.
- Applying for Too Many Cards. It’s tempting to open lots of cards so you’ll have lots of available credit. However, to lenders, doing this makes it look like you’re desperate for cash. Each new credit card you apply for adds a minor ding to your credit score, and those little minuses add up.
Bottom Line: Is a Credit Card Right for You?
In the credit card debate, there’s something to be said for both sides. Credit cards can either help you or hurt you, depending on how you use them.
Treating your credit card as free money, never thinking about whether you can really afford what you’re buying, is a one-way ticket to financial ruin. But if you stick to a budget and pay off your balance each month, a card can save you time and even put some extra cash in your pocket.
To enjoy the benefits of credit cards while avoiding their pitfalls, keep a few simple tips in mind:
- Pay in Full Every Month. First and foremost, pay your bill in full each month to avoid interest payments. If you ever have to run up a balance for an emergency, pay it off as fast as possible.
- Read the Fine Print and Avoid Fees. Second, avoid fees whenever possible. Keep a close eye on your account to avoid making late payments or going over your credit limit, and steer clear of cash advances and balance transfers.
- Watch Your Spending. Pay attention to prices, and keep an eye on your balance throughout the month to remind yourself how much you’ve spent already. And if you’re going somewhere you have trouble controlling your shopping impulses, try leaving your card at home and limiting yourself to the cash in your wallet.