Are Credit Cards Good or Bad?

It depends...

Whether a credit card is good or bad for you depends on your situation and how you handle the monthly credit card statement. Basically, there are two types of credit card customers – first those who payoff their entire monthly credit card statement balance every month, and second those who don’t pay the complete balance (and carry forward the balance to the next month).

You Payoff Your Entire Monthly Balance

If you payoff the entire balance on your credit card statement, the credit card should be good for you (though may not be good for the credit card company). You typically enjoy interest-free purchases during the month and get additional grace period of two-three weeks to payoff the balance after you receive the monthly statement. Depending on the type of credit card, you may get additional benefits, such as free airline tickets, discounts or even cash back. Just to give an example, during 1998-2003, TD GM Visa card gave me a credit equal to 5% of my total purchases towards purchase of a new GM vehicle. In 2003, when I purchased a GM car, I ended up getting a discount of about $1,800 due to purchases on my TD GM Visa card. Now I have a cash back card that gives me 1% of my net purchases on the card back to me at the end of the year. Besides, some credit card may provide additional benefits, such as free insurance on rental cars, extended warranties and common carrier accident insurance.

You Don’t Payoff the Complete Credit Card Balance

If you don’t payoff the complete credit card balance every month, you don’t get the privilege of interest-free purchases. The credit card company starts changing you interest from the day the transaction is posted to your account. Besides, you don’t get any interest-free grace period to make the payment after you receive your monthly statement. Now the interest the credit card company charges depends on various factors, such as the type of the card, issuing company, your credit history and past payment record. In any case, the interest rate you pay to the credit card company is huge, typically in the range of 18%-50% per annum or about 1.5% to 4% per month.

On your credit card statements, you see two numbers – balance due and minimum payment due. For example, the balance due could be $1000 and minimum payment due could be $20 or $30 (typically 2 to 3% of the balance or $10, whichever is more). As long as you continue to make the minimum payment, the credit card company will continue to allow you to make additional purchases on the credit card. But, do you have any idea how much time will it take to payoff the balance if you make just the minimum payments every month. Let us consider that you make a purchase of $1000 on your credit card that charges 30% interest per annum and the minimum payment is 3% of the outstanding balance or $10, whichever is more. If you just make the minimum payment every month, it will take 292 months (24 years and 4 months) to completely payoff the $1,000 purchase. In that time, you would also pay $3,726.01 in interest! Paying $3,726.01 in interest just for the convenience of buying something when you don’t have ready cash is huge price!

The moral of the story is that if you can’t payoff the complete balance at the end of the month, you should cut your credit cards in two. If you carry balance on your credit cards, you should try to payoff the balance as soon as possible (and don’t buy anything on that credit card until the balance is paid in full.) Any one, particularly students, who has no regular income, should never get a credit card. On the other hand, if you have regular income and are confident that you can completely payoff your credit card balance at the end of the month, it is okay to use credit card, however, you should always remember your limit.

It is not always possible to go completely credit card free. For instance, many hotels and rental car companies won’t make a booking or handover the keys of the car/hotel room without first having a valid credit card. To take care of such situations, or to make an online purchase, there is no harm to keep a low-limit credit card. But, always remember your limit!

Note: It is estimated that in USA, about 40% card holders carry balance. In 2008, the average credit card balance was $11,000, which was about $4,000 15 years ago. Figures for Canada are quite similar to those for USA.