Credit cards are a great financial tool but pose some consumer risks. If you are considering getting your first credit card or currently have one, you should know the dangers of credit cards. Learn the potential pitfalls of credit cards and how to manage your finances wisely!
How Does Credit Card Usage Affect My Credit?
Your credit card usage directly affects your credit score. Knowing how different actions can increase or decrease your credit rating is crucial. For example, suppose you constantly forget to pay bills on time. In that case, you may find getting a Tier 1 credit score impossible because your payment history is the most critical factor for FICO score calculation.
As you can see, specific financial actions can significantly impact your credit score:
- Payment History (35%) – Paying your monthly debts on time.
- Total Debt (30%) – The total amount of money you have to spend compared to your credit card debt.
- Length of Credit History (15%) – How long you have held credit accounts.
- New Credit Inquiries (10%) – The number of times you apply for new accounts.
- Credit Mix (10%) – The type of financial accounts you have.
Why Are Credit Cards Dangerous for Consumers?
Credit cards are dangerous for a variety of reasons. However, you should not avoid using credit cards simply because they pose some financial risks. Every financial tool has pros and cons for borrowers. As long as you know the ins and outs of how credit cards work, you can avoid the hidden dangers of credit cards.
Using All of Your Available Credit Card Balance
Credit cards are convenient because you can quickly pay off large purchases over an extended period. However, high credit card balances can result in poor credit scores and unmanageable payments.
Your credit limit is the total amount you can spend using your credit card. Credit limits can be very high if you have good credit. Suppose your credit card issuer gives you a $2,000 credit limit. Even if you have $2,000 to spend, you should avoid maxing out your credit card! Carrying a credit card balance will result in interest charges every month. Interest rates can be very high for credit cards.
Although you can make the minimum payment every month, that amount is dependent on your outstanding balance. The way a credit card company calculates a credit card payment can result in an unaffordable monthly bill that causes you to fall behind on payments! Being mindful of your spending can prevent financial issues down the line. A good rule of thumb is avoiding large purchases you cannot afford to pay off immediately.
There Is No Repayment Plan
Unlike installment loans, credit cards do not have a repayment schedule. You do not have to pay off your credit card debt by a specific date, which is convenient but also financially stressful. You must have a budget plan to pay off credit card accounts successfully. If you always make minimum payments, paying off your credit card will take you much longer. By extending the payoff date, you may end up throwing away hundreds of dollars!
A budget plan can help you pay down credit cards—even with a low income! The debt snowball or avalanche method are great options for paying off your credit card debt. The snowball method focuses on the credit card with the smallest debt amount. In contrast, the avalanche method focuses on the credit card with the highest interest rate.
Missing Credit Card Payments
If you miss a credit card payment, you can damage your credit score and your finances! Late payments will incur a late fee, which can range from $15 to $35. Multiple missing payments can increase the amount of the late fee, so you may end up losing a lot of money.
If a credit card payment is late for more than 60 days, you can receive a 29.99% penalty APR! A penalty APR will apply to your entire balance. According to Experian, you may have to make six continuous on-time payments to revert to your original APR.
Once a monthly payment is at least 30 days late, the credit card company will likely report the missed payment to the major credit bureaus. Late payments will remain on your credit report for seven years starting the date of the missed payment! Late payments may limit your financial opportunities in the future, so ensure you always make payments on time.
Applying for Too Many Credit Cards
Sometimes you may not get sufficient money with one credit card, so you may apply for more credit accounts. You may have to apply for multiple credit cards if you have a poor credit score, but that may decrease your already low credit rating.
Applying for too many credit cards within a short period can negatively affect your credit and make you look financially risky to lenders. Credit applications require a hard credit check, which results in a slight credit dip. In addition, hard inquiries will remain on your credit report for up to two years. To avoid this credit card pitfall, don’t make more than six inquiries within one year.
How To Use a Credit Card Wisely
While there are cons to using credit cards, there are also several perks! You can avoid excess fees and financial hurdles as long as you know how to use a credit card wisely. Keep reading to learn how to best use credit cards responsibly.
Make Timely Monthly Payments
Credit cards can help you afford large purchases and build credit! You can slowly build an excellent credit score over time by making continuous on-time payments. Your payment history is the most important factor for credit, as it accounts for 35% of your total FICO score. Consumers with a reliable payment history are eligible for the best interest rates and the highest credit limits. To avoid potential late payments, you can sign up for automatic payments! You can get payments automatically deducted from your bank account every month!
Carefully Consider Making Large Purchases
Spending within your means is the best way to avoid unmanageable credit card debt. Credit cards are convenient because they can help consumers afford large purchases, so what if you want to buy something expensive? Carrying a credit card balance will result in high-interest fees, so remember that paying a purchase off sooner rather than later is ideal. An online credit card payoff calculator can help you determine how long it’ll take to pay off a large purchase and how much interest you will pay. Seeing how much you lose in interest charges may incentivize you to rethink large purchases.
Avoid a High Amount of Credit Card Debt
Having credit card debt is not a problem as long as you manage your finances. But you may ask, “How much credit card debt is too much?” Credit utilization is the amount of debt you have compared to how much money you have available to spend. If your credit utilization ratio is higher than 30%, you have too much credit card debt.
To calculate your utilization ratio, follow these steps:
- Add up all of your current credit card balances.
- Add up all of your credit card limits.
- Divide your total credit card balance by your total credit limit.
- Multiply your answer from Step 3 by 100.
- The answer from Step 4 is your credit utilization ratio as a percentage!
If your utilization ratio is higher than 30%, it may be time to start prioritizing a repayment plan. However, you can also try asking your credit card issuer for a credit limit increase. You can ask for a credit limit increase to improve your credit score and decrease your utilization ratio. But how long does it take to increase a credit limit? If you have made at least four months of on-time payments, you can try requesting more money to spend. Consumers with excellent payment history may qualify for a credit limit increase at least once a year!
Avoid Extra Fees
Credit cards come with a lot of fees that can cost you a lot of money. To avoid paying more than you should, read about some common interest charges below.
- Annual Fees – An annual fee is a yearly charge for using certain credit cards. The cost of an annual fee ranges from $95 to $500. Opt for no-annual-fee cards to avoid paying annual fees.
- Late Payment Fees – When a payment is made late, you will have to pay a late fee. Late payment fees range from $29 to $40. You can avoid late fees by using payment reminders or signing up for auto-pay.
- Cash Advance Fees – When you withdraw cash using your credit card at an ATM, you will have to pay a cash advance fee. Most credit card companies charge a 3% or 5% fee per cash advance. If you need cash, consider asking friends or family members.
- Foreign Transaction Fee – Using your credit card outside the U.S. will typically result in a 3% fee per transaction. To avoid this fee, use cards without foreign transaction fees.
- Balance Transfer Fee – You will have to pay balance transfer fees for moving credit card debt from one card to another. You can consolidate credit card debt using online quick cash loans to save money on interest and get a decent repayment plan.
- Over-the-Limit Fee – You may have to pay an over-the-limit fee if you opt-in for over-the-limit fees and exceed your credit limit. Don’t opt-in for over-the-limit fees to avoid overspending and additional fees.
- Returned Payment Fee – When a scheduled payment gets returned, the credit card issuer may charge a returned payment fee. Returned payment fees are typically up to $40. Ensure you have enough money in your checking account before a payment goes through to avoid returned payments.
The Bottom Line: Dangers of Credit Cards
Credit cards can be dangerous if you don’t understand how they work. But knowing the various APRs and fees can help you make better financial decisions. Remember that credit card usage greatly affects your credit. Using credit cards responsibly can help you save money and build a great credit score.