Credit Cards

Credit Cards: Dispelling the Myths

There are many misconceptions about Credit Cards out there and before getting involved in churning them, it is important to understand the truth. Check out the list below for 5 myths and preconceptions that I hear all the time about credit cards.

1) Getting Multiple Credit Cards Will Hurt My Credit

Your score will definitely take a little ding from applying for a new credit card. This drop is due to a new hard pull on your account. A new HP can take around 10 points off of your score but these are temporary reductions and it typically takes about 3 months to recover those points. Aside from the loss from HPs another negative for opening a new credit card is that your AAOA (average age of accounts) will also drop. Your average age of accounts is exactly what it sounds like. The average age of all of your accounts in months is averaged. Here's an example.

Let's say I have the following credit profile:

  1. Student loans that were assigned 5 years ago
  2. A credit card opened 3 years ago
  3. A credit card opened 1 year ago

In this situation my average age of accounts would be as follows:

5(12)+3(12)+1(12)=108 months / 3 accounts= 36 months = 3 years

If I were to apply for a new credit card that would reduce the average to the following:

5(12)+3(12)+1(12)+0=108 months / 4 accounts= 27 months = 2 years and 3 months

As you can see about 9 months was lost due to the additional card. This is not extremely significant especially if you have multiple cards or accounts that have been opened for a significant amount of time. Each new account will continue to age along with all existing accounts and your AAOA will rebound relatively quickly. This is only a large detriment if you have a thin credit profile.

2) Paying Interest Is Good For Your Credit

It is a common belief that paying interest on credit card purchases is a good way to build credit. This is outright false. Paying interest has no effect on your score and will only hurt you as the consumer. "Paid Interest" is not a metric that banks report to credit bureaus and therefore it does not actually effect your score. A good place to monitor your Experian score is through their own credit monitoring service.

Interest rates can be ridiculous and there is no reason to waste money because of them. Check out the screen shot below of one of the APR's for a credit card I have.

Credit Card APR

3) Carrying A Balance Is Bad

A very common myth about credit cards is that carrying a balance is bad. This is actually a misconception. Utilization percentage is the metric that banks provide to the credit reporting agencies after each statement period is complete. A utilization of 30% looks awful because it shows that you are using a high percentage of your available credit and that you are on the riskier side as a customer.

On the opposite side of the spectrum, a utilization of 0% tells the banks that you are not using the credit available to you and that means it is difficult to calculate how safe lending to you is. Without proof of on time payments, it is difficult to determine if a user is trustworthy and thus a 0% utilization is also detrimental.

To improve your credit, it is important to have a utilization percentage greater than 0% but less than 10%. Doing this will show that you are actively using your card and paying most of it off as you go.

4) If I Carry A Balance I Will Pay Interest

Very commonly people misinterpret what accrues interest when it comes to credit card balances. Check out the inforgraphic below that descibes the way that interest is calculated. Important phrases to understand relating to this can be seen to the right of the graphic:

 

  • Closing Date - The date all unpaid charges are added together to determine the statement balance. Typically 2 to 3 days after payment due date.
  • Minimum Payment - The minimum amount required to pay towards your statement balance prior to your next statement.
  • Statement Balance - The amount of new charges that have not been paid off as of your closing date.
  • Total Balance - The sum of all current charges and the previous unpaid statement balance.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Paying interest on credit card debt can lead to a huge loss as time goes on and interest compounds. It is important to understand the huge impact this will have on long term costs before getting involved with credit cards.

5) I Am Better Off Using My Debit Card

The idea of credit cards vs. debit cards/cash was a big topic in my introduction post to credit cards. The basis of the idea is that it is easier to track a debit card when compared to a credit card thus making it simpler to budget. While this may be true, there are many reasons why credit cards are better in the long run. Check out my previous post referenced above for a few reasons, and below for some more:

  • When you use credit cards you are spending The Bank's Money until you pay off your bill.
  • Credit cards allow you to plan purchases ahead of having the money for them.
  • Easy to track where your money is going compared to cash.
  • Minimum 1% return on all purchases.

The most helpful bullet point above will be the first one. To elaborate on it, every dollar you spend on your credit card is the bank's money, not your own. This means that if there is a fraudulent purchase, it is much easier to get your money back from a credit card than from a debit card because with a debit card you are spending your own money. 

I have had to all my credit card company over fraudulent charges many times in the past and each instance was fixed in a matter of minutes. Even when I paid for something and never received it, I was able to do a charge back on my credit card and got the money back within a few days. For these reasons alone, I always put my purchases on a credit card.

In Closing

I hope that the above myths have officially been disproven for you. There are always more misconceptions to clear up but to me, these are the most important. As always, if you have any questions feel free to comment or reach out to me.

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