Credit Cards: Advantages & Disadvantages

There are advantages and disadvantages to using credit cards.  For some, credit cards are a useful tool in a consumer’s box of payment options.  For others, credit cards are a never ending source of debt and a constant drain on family finances.

If you have receive a pre-approval notice, or are thinking about applying for a credit card, take a moment and review the credit card advantages and disadvantages listed below.  Knowing how credit cards work and having a good understanding of the potential pit falls of credit card usage can make you a more informed consumer and a better borrower.

Pros of Using Credit Cards

Convenience – Credit cards are one of the most ubiquitous forms of consumer payment available on the market. Most cards are accepted at nearly all retailers, whether online or at in-store locations.  In fact, they are usable in so many locations, from grocery stores to car dealerships, that consumers rarely need to carry cash.

Record Keeping – To keep track of your cash purchases you will need to get a receipt from every store at which you shop, which is sometimes neither possible nor practical.  This can make month-end or year-end accounting a nightmare.  Credit cards companies, on the other hand, track your purchases and make that information available online in a neat, easily accessible spreadsheet of sorts.  Most credit card companies allow you to enter budgets, set spending limits on your card, and categorize spending so that your statements are sorted according to your unique spending habits. Most credit card companies allow you to export purchasing data to your local computer accounting software, making data entry and analysis even easier.

Company Perks – Most credit card companies offer programs which give you perks based on the money you charge on the card.  A popular program is airline miles, by which you obtain one, or several, airline miles (or points) for each dollar you spend on the card.  Once you accumulate a certain amount of points you can book a free airline ticket.  Another popular perk program is the credit card offering cash back, which, for every dollar you spend on your credit card you receive a certain percent back in cash or in credit off your next payment.  Some credit card companies offer discounts at stores and retail locations, and some credit card companies even give you access to exclusive memberships and savings clubs.

Purchase Protection – Sometimes the things we buy are lost, stolen, or broken. If we buy them with cash, we can rarely recover the lost payment or get a replacement item, without having to pay additional fees, or to re-purchase the entire item again.  However, credit cards offer purchase protection programs which allow you to recover the cost of an item is it is lost, stolen, or damaged, and if it was purchased using that particular credit card.  It’s akin to having an automatic insurance program with every purchase you make.  The purchase program works mostly with consumer items like electronics, furniture, jewelry, and the like.  Consumable items like food and auto fuel are rarely, if ever, covered under credit card purchase protection programs.  With some credit cards, purchase protection is offered free to users, while other companies charge a few dollars a month for this added service.

Identity Theft Protection – Identity theft is a rising concern for all consumers, not just credit card users.  However, credit card companies have stepped up with purchase and identity protection plans that can help you avoid identity theft, or recover money if you do become a victim. 

Effect on your Credit Score – One of the surest ways to improve your credit score is to add trade lines to your credit profile.  All credit card companies report your credit activity to the credit reporting agencies, which can help improve your score.  If you use credit wisely, and don’t maintain too high a credit card balance relative to your maximum credit limit, your credit card usage will likely contribute in a positive way, helping to raise your credit score. Thus, a credit card can actually help you overcome bad credit, through proper, long-term usage. However, if the credit card is not used wisely, it can work to damage your credit score, and that is discussed more below under credit card disadvantages.

Cash Advances – This is another category which serves as both an advantage and disadvantage.  Most credit cards allow you to take a cash advance.  In this way, your credit card works almost like a cash machine, allowing you to tap into your credit line and to withdraw cash.  You can take a cash advance through most banks, ATM and cash machines, and even at some local retail stores. A cash advance would be used in those very few situations where the place at which you are making a purchase does not accept credit cards.  It can also be used to make a payment to an individual who does not accept credit cards.  For example, if you are purchasing something privately from an individual, but you don’t have the cash available to make the purchase, you could use a cash advance through your credit card to obtain the cash or a cashiers check to pay that individual.  Cash advances usually carry higher than normal fees and interest rates, and for that reason they are discussed below in the disadvantage section as well.

Cons of Using Credit Cards

Cash Advances – While convenient, cash advances can also be a disadvantage of credit cards, if not used properly.  Some consumers who get used to the ease of credit card access will too often tap into their credit lines through cash advances.  Many credit card companies have cash advance fees based on a flat fee per advance or as a percentage of the amount advanced.  Either way, the fees can pile up quickly; and when combined with the higher than normal interest rates associated with cash advances, a credit card user can quickly find themselves at their credit limit, or behind in payments.  In the past, payments you made to your credit card each month would go first toward regular purchases at lower interest rates, and lastly to the cash advances.  That served to keep credit card balances high and profits higher for the credit card companies.  New regulations force credit card companies to apply your payments to the higher interest debt first, and while this is an improvement over older practices, cash advances are still associated with higher interest rates and fees across most credit card companies.

Reports to the Credit Bureaus – If you make late payments to your card, or stop paying altogether, the credit card companies are often the first to report that data to the credit reporting agencies.  This will have an adverse affect on your credit score and can affect your chances of getting credit in the future; not only credit cards, but also things like home mortgages, car loans, car and health insurance, store charge cards, and even student loans.

High Interest Rates– Credit cards usually feature interest rates higher than those at which you can borrow from banks.  In general, the credit card interest rates will be a few percentage points higher than what you would receive on a personal loan, but in some cases the interest rate can be in the mid-teens.  If you miss a payment or default on your credit card interest rates can rise to over 20% per anum.  The higher the interest rate, the more you will pay each month on that card.  If you pay only the minimum balance (usually 3-4% of the outstanding balance at any given time) higher interest rates will cause the credit line to negatively amortize, raising your outstanding balance and extending the amount of time you will be forced to make payments.

Teaser Rates – Most credit card companies offer low teaser rates, allowing you to make purchases at low or zero interest.  However, those teaser rates often expire after only a few months, at which time interest rates can balloon, making payments unnaffordable for those carrying large balances.

High Fees – Like banks with insufficient funds fees, credit card companies also charge fees when you go over your credit limit or miss a monthly payment.  These fees can be as much as $40 per month, which get added to your outstanding balance and can compound if not paid down promptly.  Some credit card companies also charge maintenance fees on a yearly basis, just to have an open line of credit.

Ability to Get in Over Your Head Quickly – Many borrowers get in over their heads when the access to easy credit is made available to them. High interest rates and fees can push your balance, and monthly payments, into a range where it is hard to recover.  Again, those who make only minimum monthly payments will find themselves paying on their credit cards for months and months, far surpassing the cost of the item which they purchased.

Summary

Credit cards can be a convenient way to pay for items, but they can also become a burden if not used properly.  Before accepting the terms of any credit card, make sure to closely read the company’s credit card policy, interest rate features, and payment requirements.  To use credit properly, make sure you purchase only those items for which you know you will soon have available cash.  That way, you refrain from running high balances, paying interest, increasing the cost of the items purchased.


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