Credit cards are potentially dangerous, especially for new credit card users, who may be fascinated by the allure of what seems like “free” money. Even some experienced credit card users still fall into credit card traps.
If you’re thinking about getting a credit card—or wondering whether to drop your credit card—understanding the dangers that come along with credit cards can help you cultivate better credit card habits. There are ways to use credit cards responsibly and avoid the traps that so many consumers risk falling into each day.
The Temptation to Overspend
Studies show that consumers spend more when they’re paying with credit cards than when paying with cash. In one study, participants were willing to spend twice as much when using credit cards instead of cash. It’s easy and convenient to spend money with a credit card, and you don’t feel the “pain” of cash leaving your wallet. It might also explain the rising rate of credit card indebtedness in the U.S.
How to avoid it: Set a personal spending limit with your credit card, even if it’s below your credit limit, based on how much you can afford to pay on your credit card each month. Be careful that you're not overspending to live a lifestyle you really can't afford or to impress people with your plastic.
Interest Makes It Harder to Pay Off the Balance
Paying credit card balances in full each month allows you to avoid paying any interest at all. If you’re not paying your balance in full, then a portion of each payment goes toward interest payments, increasing the amount of time it takes to pay off your balance.
How to avoid it: Pay your balance in full to avoid paying any interest on purchases. If you can’t pay in full, you may be charging more than you can afford to pay, but pay as much as you can each month until you've brought your balance to zero.
Risk of Getting Into Debt
Any time you borrow money, you’re creating debt. The more you borrow, without repaying, the deeper you go into debt. Debt leads to a myriad of other problems, and not all of them are financial. Debt can lead to stress, depression, and other health issues, all of which can have serious impacts.
Once you’re in debt, reaching your other financial goals is much harder. Spending money on debt leaves you with less money for other priorities like saving for retirement or summer vacation. You may have to delay your educational goals or feel trapped in a job you don’t like because you need to pay your bills.
How to avoid it: Recognize the signs that you’re headed for credit card debt, particularly not being able to pay your balance in full each month. Stop using your credit cards and focus on living within your means to keep from getting in over your head.
Risk of Ruining Your Credit Score
Credit cards have a major impact on your credit score. Use your credit card wisely, and you’re on the way to a great credit score. But, if you make a mistake—like miss a payment for 30 or more days—your credit score will take a hit. The more you mess up, the more your credit score will fall.
How to avoid it: The best way to build and protect your credit score is to pay your credit card on time, keep your balance below 30% of your credit limit, and minimize the credit card applications you make.
Minimum Payments Can Create a False Sense of Security
Your credit card issuer only requires you to make a small payment each month to avoid late fees and keep your account in good standing. Unfortunately, next to making no payment at all, minimum payments are the worst way to pay off your balance. You’ll spend more time paying your balance, and you'll pay more interest if you make only the minimum payment.
How to avoid it: Paying your balance in full is ideal, but if you can’t pay off your entire balance, pay more than the minimum to get rid of your balance sooner and reduce the amount of interest you pay overall.
Confusing Credit Card Terms
While credit card terms have become a lot clearer thanks to the Credit CARD Act of 2009, there still is a lot of confusion with credit card offers. A single credit card can have several different interest rates and knowing which rate applies can be confusing. Misunderstanding your credit card terms can have serious consequences—like increased fees or interest rates or damage to your credit.
How to avoid it: Understand the different types of balances you can carry on your credit card and the interest rate that applies to each. Read through your rewards program to learn what purchases earn rewards. Contact your credit card’s customer service with questions about your credit card.
It's Harder to Track Spending, Especially Across Multiple Credit Cards
Tracking your spending is a foundation of a healthy financial life, but adding credit cards to your usual spending methods can make it more difficult to keep up with all your spending. It is especially true if you’re using your credit cards along with cash and debit, and if you’re using multiple credit cards. It is one of the reasons credit cards make it so easy to overspend.
How to avoid it: Using more cards means you have to look in different places when you’re tracking your expenses. You can track them manually in a spending journal or spreadsheet, or use a personal finance software like Mint or Quicken to help track your spending.
Credit Cards Come With a Risk of Credit Card Fraud
To some degree, everyone with a credit card is at risk of being a victim of credit card fraud. Your credit card itself can be stolen, or a thief can steal your credit card information from a company you’ve shopped with. Thankfully, your liability for fraudulent credit card purchases is limited, but you have to report these charges quickly.
How to avoid it: Monitor your credit card often and report a missing credit card or suspicious charges immediately.