I once witnessed someone installing a beautiful, cut-glass window by pounding the frame around the window into place with a hammer. The results were predictable. The glass shattered. The church where the glass was being installed would have to wait until another window could be custom-ordered. Worse, it was a wasted expense.
Moral of the story: A hammer is a wonderful tool, but it isn’t right for every project.
Credit cards are the same way. They’re a great tool, but if you use them the wrong way, your personal finances can shatter.
Misuse #1: Carry frivolous balances
When you carry a balance on your credit cards, you’re paying a fee. Incurring debt on unexpected expenses can often be necessary to keep emergences from disrupting your life. But, paying interest on a pair of shoes that were on sale means they end up being a lot more expensive than the price tag indicates.
Misuse #2: Paying only the minimum
If you only pay the “minimum due” each month on your credit card, the amount of interest paid will be huge compared to the debt. Let’s look at an example using a helpful credit card calculator:
Credit card balance = $1,000 (APR is 28%)
Minimum amount due = $25 or 3% (whichever is greater)
If you only pay the minimum due each month (and don’t make any other purchases on the card), it will take you 93 months to pay off the balance. That equals $1,380.37 in interest charges.
Misuse #3: Using all of your “available credit”
Credit card statements show your “available credit” so you know how much more you can charge on the card. The problem is that if you’re using all of your “available credit” (even if you pay most or all of it off every month), you’re hurting your credit score. Utilization is the percentage of the credit extended to you that you use. The larger the percentage of your utilization, the more it impacts your credit score. There is no magic threshold.
Misuse #4: Not using it at all
If you get a credit card and never use it, your credit report will show very low utilization. However, you won’t benefit from the most important factor in building and maintaining a good credit score which is a positive payment history. Without making payments, you won’t have a payment history on your credit report.
But, don’t fall prey to misuse #5…
Misuse #5: Using a balance as payment history
Using the card is not the same thing as carrying a balance. Buying a pack of gum with your credit card every month and paying it off counts as positive payment history. You don’t need to pay the credit card companies any interest for a carried balance to take advantage of the benefits you can gain on your credit report for maintaining a positive payment history.
Misuse #6: Treat your credit card separately than other bills
Some people put their recurring bills (like a phone or cable bill) on their credit cards. They don’t want to forget to pay them and they like the convenience of knowing they are taken care of. After all, that’s one less thing to think about. But, then they think of their credit card bill as somehow different.
Your credit card bill is like any other bill that needs to be paid. If you can stay on top of your other bills by setting up automatic payments, you should do the same thing with your credit card. A best practice is to setup auto-pay, so you aren’t tempted to consider your “available credit” as a reason to not make more than the minimum payment.
A powerful tool
Just like the hammer shattered the window, swinging your credit card around can shatter your credit score. But, it doesn’t need to be that way. Credit cards are one of the most powerful tools available for helping build your credit. Using the tool the right way can help you achieve your financial goals.
