How to Use Credit Cards (Responsibly)

Credit cards, like many topics related to personal finance, are polarizing to say the least.

Some people avoid them entirely, saying that they’re the gateway to the slippery slope of high interest debt. The type of debt that buries people, draining hundreds, if not thousands of dollars from their bank accounts every month for decades, each payment seemingly making no dent at all, and ultimately preventing them from ever really achieving any sort of financial stability.

Others claim to take advantage of the benefits that the cards offer, like security, rewards, and convenience, seemingly earning free vacations without ever dipping even their toe into the sea of debt. These people often go years and years without paying a single cent of interest on any of their multiple credit cards.

These sound like the extremes, so where does the truth lie? Actually, when paired with some basic responsibility, that second group doesn’t seem so far-fetched.

What is Credit?#

Credit, in this sense of the word, is essentially a loan. A line of credit, like a credit card or a home equity line of credit, is basically a loan on standby; you pay no interest if you don’t use any of the borrowable money, and you can borrow money at will (up to a predefined maximum).

For example, let’s say you use a credit card to buy something for one dollar. When the card gets swiped at the cash register, the bank that issued you the credit card pays the merchant one dollar. You now owe the bank that one dollar, which you can repay to the bank at a later date.

Credit cards typically work in monthly cycles, at the end of which you’ll receive a bill called a statement. The statement lists all of the purchases made on the card in that month, as well as any payments toward previous statements, and any interest that accrued on the balance of the previous month’s statement.

The important part to know is that credit cards have grace periods. Once a credit card cycle closes and a statement is created for that cycle, the owner of the card typically has a couple of weeks to put money toward the balance of the statement before interest begins accruing. The amount paid must be at least the value of the minimum payment listed on the statement in order to avoid a penalty. If the entire balance of the statement is paid in full before the grace period ends, no interest accrues.

This is important. It means that if you always pay off the entire balance of the statement before the end of that month’s grace period, your credit card is effectively interest-free. Interest will be charged on any unpaid portion of the statement balance that remains after the grace period ends.

How are Credit Cards Dangerous?#

Credit cards can be extremely dangerous for those that separate the card’s available credit from the money that will eventually be used to pay off that used credit. For example, if I have a card with a $10,000 credit limit, that means that the bank that issued the card will let me buy up to $10,000 worth of whatever I want, even if I don’t have $10,000.

So what happens when the cycle ends, and I’ve spent $10,000 but don’t have enough to pay it back? Well, I can pay at least the minimum payment, which might be something like $100. Now my balance is only $9900 since I’ve freed up $100 to use on the credit card again! All is good, right?

No. Now I’m paying interest on the remaining $9900, and it’s likely accruing interest at a rate above 20% per year. This means that I’d owe $9900 x (20% / 12) = $165 in interest, plus the remaining $9900 from the remaining balance, which totals to $10,065. That’s more than I originally spent on the card, despite the fact that I put some money toward paying the balance off.

This is where credit cards become dangerous. It’s extremely important that if you use a credit card to buy anything, that you use it the same way you would use cash or a debit card - to spend money that you already have.¹

Just remember what Peter Parker’s uncle said:

With great credit comes great responsibility.

Or something like that.

Simple Tips for Responsible Use#

So you want to use credit cards responsibly? All it takes is following two guidelines.

• Pay your statement balance in full every month. You can optionally set up autopay, so that your card is automatically paid off using the money in your bank account on a set day every month. This will ensure that you never pay a cent in interest.
• If you can’t afford to buy something right now with cash or a debit card, you can’t afford it with a credit card. Applying this mentality to your everyday purchases will help prevent you from falling into the trap of viewing a credit card as a magic money device that lets you purchase more than you can afford.

That’s it! Remember these rules and you’ll be a responsible credit card user in no time. This will have a positive impact on your credit score, a numerical representation of your reliability in regards to paying off debt, which will help Future You get a loan like a mortgage, or pass a credit check that’s frequently performed by landlords or potential employers.

Conclusion#

Credit cards are often portrayed as the Boogeyman in the personal finance community. But they aren’t; they can be just as cheap (free) as using cash or a debit card. In fact, I’d take it a step further and say that it’s a good idea to use a credit card for every single purchase you make, a topic I’ll begin to discuss in depth in the next post.