Chapter 9 - Credit Cards

You may wish to review the discussion in Chapter 2 about the financial planning lifecycle and how we take money from our future in order to pay for our present lifestyle.

Types of Credit

All consumer credit is classified as either installment or non-installment credit.

1. Installment credit is characterized through the regular repayment of principal (the amount that you borrowed) and interest through equal monthly payments. The most common forms of installment credit are mortgages, student loans, and automobile loans.

2. Non-installment credit involves single payment loans, credit cards, and home equity lines of credit. The have no fixed payment schedule. Payments can be scheduled any way the lender likes. This is not possible on installment loans.

Service credits are issued by a service provider whenever they do not require payment in full in advance. These types of credit are frequently used by utility companies, dentists, and physicians to assist customers in paying large bills. These can be either installment loans or non-installment loans. It is up to the service provider to decide which type they wish to use.

Credit Cards

Credit cards and other lines of credit are also called revolving credit. We call these "revolving" because money can flow in and out easily, just like people can enter and exit a building freely through a revolving door. They are a very convenient method of making payments. They are also good for building your credit history and improving your credit score. Many credit cards also offer rewards for those who use them.

These benefits must be carefully balanced against the dangers of credit card use. Research shows that, in general, people are more willing to spend money on a credit card than they are willing to spend cash. Credit cards can get you into a lot of trouble if you are not careful!

Choosing a credit card

When you are considering which credit card to choose, there are a few criteria you should watch for.

1. The annual percentage rate, or APR. This is the interest rate of the card. It represents the cost of credit. This is the interest rate you will use in your math skills. A high APR means that the card will be expensive to use.

2. The grace period is the time between when you make a purchase and the time when interest starts being charged. The grace period is a very important characteristic of a credit card. It can determine whether or not you have to pay interest to use the credit card at all. You are charged no interest at al if you pay off the balance before the grace period expires. This means that if you pay off the card during the grace period, then the credit card charges no interest at all! Most credit cards have a grace period of one month, meaning that if you pay off the balance every month, you never get charged interest. However, not all credit cards have a monthly grace period, so it’s important to check the grace period before you sign up for the card.

3. Annual fees are also important. These fees are paid once per year regardless of how you use the card. They typically range from $50 to $150 per year, but they can be much more expensive. There are many excellent credit cards that have no fees whatsoever. If possible, you should seek to get a credit card that has no annual fee, as the fees usually outweigh any benefits or reward the card might offer.

4. You may also wish to check the quality and availability of the card’s customer service department, and check for other benefits, such as rental car insurance, discounts, rebates, and identity protection.

A secured credit card is a special type of credit card. These cards are very similar to regular credit cards except that these cards are tied to a checking or savings account (for collateral). When this money is gone, the card is worthless until additional funds are deposited. These cards are convenient, especially for building credit as credit scoring agencies cannot tell the difference between a secured and unsecured card.

Using a Credit Card

There are several appropriate uses for credit cards. They are good if you need to make a guarantee, such as when you rent a car or hotel room. They are also a good source of funding in case of emergencies. They are a very convenient way to pay for things, particularly if you are buying over the internet. Credit cards are also an excellent way to time your expenses. Because of the grace period of the card, you can use your credit card to buy things before you have to pay for them. This creates essential an interest free loan if you pay off the balance before the grace period expires. This is particularly useful for people who only get paid once per month. It lets you buy things before your paycheck is deposited. The credit card is a good way to spread your spending out until your next paycheck. Many credit cards also provide access to free services, such as extended warranties, travel insurance, airplane miles, car rentals, etc.

Risks

Credit cards, as we have mentioned earlier, have many potential downsides. When you use a credit card, it is very easy to spend money. You don’t even think about how much you are spending. It is also difficult to track what you have spent. It requires discipline to track the charges you have incurred.

When you pay cash, it is easy to track how much you spent because you can simply look at the bills you have left in your wallet. This is not possible with a credit card. Credit cards also have very high interest costs, and their use obligates your future income. This can make your life harder in the future if you borrow too much.

Security

It’s important that you protect yourself against credit card fraud. Here are a few things you can do to protect yourself:

1. Be sure to always handle your account information with care.

2. Keep your credit card receipts and compare them to your recent account activity to make sure no one else is using your card. Destroy your statements and receipts once you have compared them.

3. Always be careful to whom you give your credit card number.

4. Be aware of where your card is at all times. If your card number does get stolen, the law protects you. The most you will be responsible to pay on your stolen credit card is $50. This is the maximum allowed by law. The amount can be less than $50 depending on the credit card company. Some companies even offer zero liability protection, which means that if your card is stolen, you are responsible for none of the fraudulent charges.

Debit cards are also protected, but the protection is not as good. Limits on liability for a stolen debit card are legally allowed to be as high as $500.

If your credit card is ever stolen or lost, call the credit card company immediately. To make this easier to do, keep a copy of your card in a safe place so you know how to contact the company. There is no harm or cost involved in calling the credit card company and reporting that the card is lost. Call the credit card company immediately if you have any doubts about the security of your card. You can always unfreeze the card if you find it later.

If you are confident that the card has been stolen, you should also file a police report with the local authorities. This shows the credit card companies that you are being diligent in your efforts to prevent the fraudulent use of your card.

You should also contact the credit reporting agencies and the social security administration if your card goes missing. Have them place a fraud alert on your name and social security number. This prevents the unauthorized use of your name and credit. It also immediately alerts the authorities if anyone is attempting to use your identity.

Credit cards can be very useful in the financial planning process, but they must be used with care. Try to avoid any of the following situations with your credit card.

o Making only the minimum payment each month

o Reaching your credit limit on a credit card

o Not knowing your balance before you get your monthly statement

o Using cash advances on your credit card

By keeping an eye on these questions and remembering your money personality, you will be prepared to use your credit cards in a safe and responsible manner.

Definitions:

Installment credit: the regular repayment of principal (the amount that you borrowed) and interest through equal monthly payments

Non-installment credit: single payment loans, open-ended credit like credit cards and home equity lines of credit

Open-ended credit: also called revolving credit, money can flow in and out easily, just like people can enter and exit a building freely through a revolving door

Service credits: credits issued by a service provider whenever they do not require payment in full in advance

Annual percentage rate: APR is the interest rate of the card, and represents the cost of credit

Grace period: the time between when you make a purchase and the time when interest starts being charged

Secured credit card: like a credit card, but tied to a checking or savings account for collateral