A Closer Look at Credit Cards
Myth: One Credit Card Is All You Need
Fact: Before the recession began in 2007, that may have been true. But since then issuers have been closing accounts and cutting limits, even on customers with good credit histories, says Linda Sherry, a spokesperson for Consumer Action, a San Francisco–based watchdog group.
As a result, you need at least two credit cards (excluding store cards), since you may never know when an issuer will slash your limit or close your account, says Gerri Detweiler, a personal-finance adviser for Credit.com, an independent education website. Also, the average limit on a new card is now just $3,972, down from $4,897 in 2008, according to Equifax, and at times you may need to make larger charges.
Your main card should be a rewards card, ideally a no-fee cash-back version, which will give you a rebate of up to 5 percent on everyday purchases, from gas to groceries. (See The Top-Five Rewards Cards for great card suggestions.)
The second card should be a backup, to be used primarily for emergency expenses, says Detweiler—for example, your refrigerator dies and you need a new one right away. Make sure the card has a low interest rate (look for an annual percentage rate, or APR, in the midteens, ideally lower than 12 percent) and a high limit, such as $5,000 or more. Then remember to use the backup card occasionally—for a tank of gas or a dinner out—since you could lose the account if your card is inactive. “You won’t have an established history with the issuer, so they may view you as a liability, since you have all this outstanding credit that you could tap into suddenly,” says Barry Paperno, a consumer-operations manager for MyFICO.com, the consumer division of the credit-score company FICO.
If you already have more than two cards, as lots of people do, don’t rush to close the extra accounts. Keep them, as long as you’re using them responsibly—meaning, you pay the balance every month and maintain a credit-utilization ratio under 10 percent. But if you have problems keeping on top of all of them—you don’t always pay your bills on time and often carry a balance on multiple cards—then you might want to reduce the number you’re carrying to two.
Myth: Paying an Annual Fee Is a Waste of Money
Fact: Actually, the card can be worth the price. Before you sign up for one, do some calculations to see if the benefits you receive pay for or exceed the yearly charge. There are numerous cards (often ones with travel-related rewards) that may meet this criterion. For example, Delta’s Gold SkyMiles American Express card ($95 annual fee, waived the first year) lets cardholders check one bag for free on every flight, for a savings of $50 round-trip. And the fee waiver is extended to nine people on the same reservation, so a family of four could save up to $200 with one round-trip.
Myth: There’s No Harm in Signing Up for Store Cards
Fact: Retailers entice customers to open credit-card accounts by offering promotions, discounts, rewards programs, 0 percent financing, and other perks in addition to saving (typically 10 to 15 percent) on purchases made the day you open the account. Some of these store cards can be worth having, but don’t sign up for every card you’re offered—that will put you at risk of racking up debt. “If you want retail credit cards, get them from the one or two stores that you frequent the most, since you probably won’t use them regularly and may lose track of when the bills are due,” says Bill Harde-kopf, the chief executive of LowCards.com, a credit-card-comparison site.
This rule of thumb especially holds true if you’re in the market for a loan. Why? Each application for a new credit card triggers an inquiry on your credit report; opening several accounts in a short time makes you look like a risky borrower and could reduce your credit score by up to 30 points, says Hardekopf. As a result, you might qualify only for a loan with unfavorable terms.
Another scenario in which you should never have store cards: You tend to carry a revolving balance. Issuers typically charge interest rates that exceed 20 percent (compared with an average of 14 percent and up for regular cards).
Myth: Just One Missed Payment Won’t Damage Your Credit Score
Fact: On the contrary, your score could plummet more than 100 points, says Liz Pulliam Weston, the author of Your Credit Score (FT Press, $19, amazon.com). A missed payment is particularly damaging if you have a great score (700 and up). The higher it is to begin with, the harder the fall can be. “Someone with a lower score is already seen as a risk, so their messing up is almost expected. As a result, they would potentially lose only 60 to 80 points, versus 90 to 110 for someone with stellar credit,” says Weston. Once your payment is so late that you’ve already received your next statement, there’s not a lot you can do—which is why (yes, you’ve heard this before, but it bears repeating) it’s extremely important to set up automatic bill pay.
Myth: You’ll Save Money If You Transfer a Balance From One Credit Card to Another With a Lower Interest Rate
Fact: Balance transfers offer numerous benefits: You reduce your monthly payments, save money on finance charges, pay less in interest charges, and simplify your financial life overall. But they’re not for everyone. And it requires some homework to determine whether the transaction is worthwhile.
Balance-transfer offers have gotten stingier: Transfer fees may be as high as 5 percent of the balance (meaning a $10,000 transfer would cost $500). And the best deals (for example, a 0 percent balance transfer for 18 months, available from Citi Platinum Select MasterCard, among others) are typically reserved for those with a spotless credit history.
Before you apply for a card that you plan to use for a balance transfer, find out these five important pieces of information from a company representative: how long the introductory-interest-rate period lasts; how much you need to pony up each month to pay off the balance before that time ends; the balance-transfer fee; the penalties you’ll incur for late or missed payments; and whether the teaser rate applies to new purchases.
Myth: There’s No Way Your Issuer Is Going to Reduce Your Fees or Increase Your Credit Limit
Fact: Believe it or not, it’s possible—and even quite likely—to get various goodies from your credit-card company. If you make a payment just a few days late, reiterate your generally responsible payment history to the company representative and you may get a fee reduction, says Curtis Arnold, the founder of U.S. Citizens for Fair Credit Card Terms, an advocacy group based in Little Rock. You can also finagle a lower interest rate this way. Suggest that you have been getting attractive competing offers. Tell the representative that you would like to stay on as a loyal customer but that you are weighing your options and want to know what her company can do for you.
To get your credit line increased, “start by requesting a relatively small amount, like $1,000, as opposed to $5,000,” says Arnold. If you don’t make any progress with customer service, don’t despair. Stay on the line and ask to speak with a supervisor. Keep in mind, however, that if you have maxed out your card, have poor credit, habitually skip payments, or are relatively inactive, your issuer probably won’t do you any favors. In fact, trying to negotiate could backfire, says Detweiler: “They might review your file and choose to lower your limit or close the account.”
Myth: When You Make a Purchase, There’s No Difference Between Using a Debit Card and a Credit Card
Fact: Debit cards have their benefits: Unless you overdraw, you can’t spend more money than the amount in your bank account, and you don’t have to worry about late fees or interest rates.
However, credit cards are still more reliable in a variety of ways. For starters, federal law affords credit-card consumers better protection. While credit users’ obligations are capped at $50 if fraud occurs on a card, debit-card users can be on the hook for $500 if they don’t report deceptive behavior within two days of learning about it. (Worse, they face unlimited liability if they wait more than 60 days.) A credit card should be used for online purchases and big-ticket items (furniture, vacations), since the credit-card company will refund your money if the item you purchase has been misrepresented. This is not the case with a debit card.
Additionally, when you use a debit card to buy gas, reserve a hotel room, or rent a car, the merchant can place a hold on your account without your knowledge. “In cases where the final purchase price is unknown at the exact moment of the swipe, the merchant can reserve more money for itself than you actually spend,” says Sherry. While a gas station might freeze $100 (even if you bought only $5 worth of gas), a hold at a car-rental counter could amount to hundreds of dollars, and at a hotel, it could be thousands. The hold can last a couple of days, says Sherry, and could result in your unknowingly overdrawing the account.