In an earlier post directed to Young Earners, we described a credit card as a little piece of plastic that is a powerful financial product, but which appears deceptively simple. They are ubiquitous; and we love them; and we hate them. Improperly used, they can break, no, decimate your finances. In this two-part post, we discuss the good and bad things about credit cards, and we hope by the end, you’ll understand how to avoid the woes.
- 1 Benefits
- 2 Dangers
Before we explore the dangers that they pose, we must acknowledge their numerous benefits. Can you really imagine a world without credit cards? We most certainly do not want to!
They just make life simple: just take out, swipe, sign, see you later. They are particularly useful for high dollar value transactions. Given that businesses dislike accepting personal cheques, we’d need to carry around a personal vault to keep all the cash needed to buy anything. By the way, we always challenge a business’s policy about not accepting a personal cheque – we are not standing two hours in a line to get a banker’s draft – and usually we win!
They facilitated the rise of Internet commerce
We love buying things on the internet. Apart from variety, it empowers us as consumers by cutting out the middlemen if we choose. By middlemen, we are referring to retail stores. As a general statement, in the Caribbean retail stores are abysmal. There is very little customer-first thinking, prices are sometimes unreasonably high, and depending on what is being sold, there could be few alternatives to provide the necessary competition to wake retailers out of a stupor.
Internet commerce has changed all this. We can now vote with our buying choices! We hope retailers realize the trend and make a serious effort to re-make their businesses. This wave of change would not be possible without credit cards.
As a side comment, personally, we happily support local stores that truly make an effort to win our purchase. Others, we happily ignore and leave them to their inevitable fate.
Obviously, not having to walk around with lots of cash is a tremendous plus for our personal safety.
They pay you to use them! Because we personally don’t have credit card debt, we easily “make money” from our cards, even after paying annual fees. What could be better?!
Easy access to emergency credit/cash
Because they are pre-authorized with a credit limit, they are the easiest way to access either credit or cash in an emergency, sudden hospitalizations being a good example.
Itemized list of purchases
They do a lot of work for you by giving you an itemized list of purchases every month. For the serious do-it-yourself financial planner, this makes understanding the majority of your purchases much easier, and then you really only need to track cash payments.
Addictive and easy to abuse
Let’s start with the most obvious: they are easy to love because they are so easy to use, which makes them dangerously addictive and easy to abuse.
Without a credit card, you’ll have to walk around with cash because businesses are not really accepting personal cheques anymore. With cash, it’s unlikely you’ll make a discretionary purchase worth a couple hundred dollars a few times a month. We don’t know about you, but we still wince whenever we have to break a $100.00, far less forking out a couple at a time!
But with a credit card, the psychological effect of depleting your physical cash is not there to act as a natural barrier to stop you from buying.
Fraud & Identity theft
With ease of use, comes two of the single biggest challenges: fraudulent transactions are prevalent and it is easy to become the target of identity theft. Lenders provide a lot of information on this topic, so we would not repeat it here.
The only point we will emphasize is you MUST scrutinize your statements purchase-by-purchase to make sure you agree with the charge. This is the only way you can detect both issues.
The ability to access cash from our credit cards are truly a great feature, but they are for emergencies only. Yet, we know people who use them as if they are withdrawing money from their bank account using an ATM card.
Cash advances are VERY expensive:
- You are charged a fee immediately when you withdraw, which is usually a % of the amount withdrawn (not a nominal flat fee as with an ATM card).
- And then you are charged interest from the date of withdrawal (obviously there is no interest with an ATM card). You should also confirm from your lender if a punitive rate (higher than normal) would be applied to the advance.
Bottom line, don’t use them to withdraw cash unless it is an absolute emergency.
There are three additional dangers that we identify now, but given their importance, we want to cover these in a separate post.
Most expensive form of credit
We pay in a big way for the flexibility a credit card provides us.
Unclear interest calculations
Have you ever tried to re-calculate the interest on your card? It’s very difficult.
The illusion of minimum payments
Whoever came up with the idea of “minimum monthly payments” is a genius. It appears like a recommendation and several people duly follow the “recommendation”. But in fact your lender is telling you that this is the lowest amount you need to pay in order to keep your card ACTIVE (meaning not in default).
You may not realize that from a practical point of view it is almost impossible to repay your card balance if you only make the minimum payments. (Well, to be accurate, it could just take a very very long time.)
We continue in Part 2, Understanding Credit Card Debt, where we focus on the three big items noted above.
If you want to learn more about credit cards, here is a popular reading choice from Amazon. There are a few points that don’t necessarily apply to Caribbean markets, but there is a lot of useful information nonetheless.