Is it a good idea to have a credit card? My short answer is NO!
I have 18 year old twins who just graduated from high school and they asked me if it was time for them to get a credit card because the teller at our bank told them it was time. What?! It’s no wonder that Americans owe an average of $6,354 on bank issued credit cards. Teenagers and credit cards are a horrible idea. In fact, for most adults credit cards are a horrible idea.
I’m sure all of you are thinking, “but what about building my credit score and how about all of the benefits I can get from credit card points or ‘free’ miles?”
Read on and I’ll attempt to explain..
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Why are credit cards a bad idea for most people?
According to a study released by the Boston Fed, only 35% of credit card users pay off their bill in full every month. That means 65% of people don’t pay their credit cards off every month. If you are one of the few people who do pay it off each month, you’re obviously in control of the plastic (but read on to hear my thoughts on credit cards even if you pay them off each month). For the 65% of people who do not pay off their credit card balance each month, let’s do some simple math.
Have you read my blog post on the power of compounding interest? If not, click here. Compounding interest is, at it’s simplest form, interest earned on interest. This same concept is used against you when it comes to credit card debt and what’s worse – credit card companies charge way more interest than you are ever going to earn in your savings account.
According to the federal reserve, the average interest rate charged on credit cards in 2018 was 15.32%APR. (1)
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Most credit cards come with an interest rate. Simply put, this is the price you’ll pay for borrowing money. Interest is like rent: the longer you pay interest, the more interest you pay – and at the very end, you get nothing back.
For credit cards, interest is typically expressed as a yearly rate known as annual percentage rate or APR. Though APR is expressed as an annual rate, credit card companies use it to calculate the interest charged during your monthly statement period.
How to calculate APR:
Here’s the math in case you’re interested. If not, scroll down to my thoughts on whether a credit card is needed to build credit.
The average interest rate charged on credits cards is roughly 15%. To calculate how much interest you’ll be charged, you’ll need to know your average daily balance, the number of days in your billing cycle and your APR.
Let’s say you have a travel rewards credit card and an average daily purchase balance of $1,500 at the end of your 30-day billing cycle. You also have a variable purchase APR of 15.99 percent.
Here’s how to calculate your interest charge (numbers are approximate):
- Divide your APR by the number of days in the year.
0.1599 / 365 = a 0.00044 daily periodic rate - Multiply the daily periodic rate by your average daily balance.
0.00044 x $1,500 = $0.66 - Multiply this number by the number of days (30) in your billing cycle.
$0.66 x 30 = $19.80 interest charged for this billing cycle
Just like compound interest on savings, this interest gets added to what you owe each billing period (generally each month).
The math requires some work but the concept is simple: Carry a balance, and you’ll pay interest.
The cost of paying of debt with minimum payments:
And beware of only paying the minimum balance! The minimum balance is typically calculated at 2% of your balance. A credit card balance of $5,000 with a 14% APR, will take you 22 years and $5,887 in finance charges if you only pay the minimum payment. You are literally paying double the original amount borrowed. Yikes. Great business for the credit card company; financially crippling for the borrower.
Should you have a credit card to build credit?
The whole premise of “building credit” is based off of the idea
that if you take on debt now, you can prove to the lender that you can take on more debt later. A high credit score isn’t an indicator that you are wealthy and ca really afford whatever it is that you’re applying for – credit card, car loan, mortgage, etc. A high credit score is generally an indicator that you love debt. Bankers (like the ones that approached my kids to say they needed their credit card), car dealers, and unknowledgeable lenders have told Americans for years to “build your credit” now to buy things later. They’re telling you to get debt so you can get more debt because debt is how you get stuff. It’s really a crazy logic when you think about it!
Bottom Line:
IF you are one of the 35% of Americans that payoff your credit card each month, a credit card can be utilized to obtain some “perks” but
BEWARE of the lure to spend $1000 to get $20 worth of airline credit! And, read the fine print of any credit card you are thinking about getting. Click here to read about how credit cards work and what to look for when researching the best one for you.
For the rest of the 65% of you that do not pay off your credit cards each month, I strongly discourage getting a credit card and for those that already have credit card debt, a plan to pay them off and then to cancel them! A debit card can be used for traveling and for making online purchases. The key is to save up for things before you buy them. For steps on how to payoff your credit card debt, click here. If you want to know how to cancel your credit card, click here.