The Planner's Perspective: Blind Spots of Credit Cards
By Paul Morrone CFP®, CPA/PFS, MSA
Credit cards may be one of the most widely used (or misused) and misunderstood financial tools we have available in today’s world. Companies such as Visa, MasterCard and American Express have some of the most recognizable and popular marketing campaigns, all which have successfully made their products a global presence. While the majority of credit cards available to consumers look and feel virtually the same, as always, the devil is in the details. Selecting a credit card is an important process, as you will likely have it for years (if not decades) and you want to make sure that the card’s benefits align with your needs. For some, it may be simple and they may just be looking for a card to make purchases with as credit tends to be a more convenient (and efficient) payment method in today’s modern world. But the question becomes, what does all of this mean to you, and do you know what you’re really getting, even worse, what does it cost?
Credit Score: Before you’ve even selected a credit card, the card issuer assesses the risk that you won’t pay them back for the charges you make each month. One of the main ways they do this is by evaluating your credit history and demographic information, including income and assets. Your credit score is arguably the most critical component used in determining your eligibility for any credit card. Those with higher credit scores will likely be eligible for credit cards with lower interest rates and higher credit limits. Additionally, a higher credit score may also make you a target for better introductory offers, such as balance transfers, bonus points or 0% financing offers.
Interest Rates: If your credit card is your main spending vehicle, we strongly urge you to pay the balance in full every month. The reason for this is simple: credit cards are an unsecured form of financing, meaning that the bank does not have a lien on any of your assets to collect from if you don’t pay. As a result, rates on credit cards tend to be higher than virtually all other forms of financing.
Cash Advances: Many credit cards also allow for cash advances, meaning you can use the card at an ATM and withdraw funds up to a stated limit as defined in your cardmember agreement. These are unique in the sense that the interest being charged on the cash advance begins accruing immediately, rather than from the statement date as with your other charges. Additionally, most cards assess a higher interest rate to cash advances than they do for your credit charges.
Annual Fees: Many ‘premier’ credit cards assess their users an annual fee. This may or may not be justifiable in your particular case depending upon your usage of the card and the benefits derived from those fees. Review your cardmember agreement as well as the benefits provided by the card to justify paying the fee each year. If you cannot determine a cost/benefit of having the card it may be wise to cancel the card or downgrade it to one that has a lower or no annual fee.
Foreign Transaction Fees: International travelers may be in for an unwelcome surprise after a long trip if they are not aware of their card’s policies towards foreign transactions. While each card is different, many assess a 1%-2% additional charge for each transaction processed in a foreign country. This may not seem like much at first, but when you add up the cost of a trip abroad (especially factoring in the exchange rate in countries in Europe), the 1%-2% fee can add hundreds of dollars to the total cost of a trip. Frequent international travelers may want to consider a card with no foreign transaction fees.
There are many good reasons to have a credit card, and when used appropriately they can be considered an invaluable financial tool. Unfortunately, the ease and convenience of using a card can be a slippery slope that leads many to take on more debt than they can afford. An otherwise healthy credit score can be damaged for years by only one late or missed payment on a card.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.