The short answer: Yes. While many of us are scared of credit cards because of the horrifying stories we have heard about people falling into crippling debt, they can actually be a great (and necessary) financial tool if used correctly. Let’s break down what credit cards are and how you build credit.
Credit Cards 101
A credit card is a tangible plastic card that allows you to borrow money to pay for whatever it is that you are purchasing. You can get one by applying to a credit card company which will then send you a card with a “line of credit”. A line of credit is simply the money you are allowed to borrow that month. There are a few reasons why you would want to purchase an item on credit instead of cash, but the main reason (besides not having the necessary cash on hand) is that you can begin building a credit score. In order to rent an apartment, get a mortgage, apply for a car loan, you will likely need a credit score. It is a number between 300 (worst) and 850 (best) that tells lenders how likely you are to return the money lent to you. With a high credit score, people will feel more comfortable giving you loans, but with a low credit score, you will find it difficult to borrow large sums of money. There are a number of factors that contribute to your score. Paying the full balance on your credit cards each month, building credit for many years, not holding too many accounts, and consistently using your credit card will all lead to you having a higher score.
Smart Credit Habits
While a credit card can be an incredibly useful tool, it is very important that you have smart credit habits. You need to be responsible with a credit card, as one big mistake can set you back for a long time. However, there’s no need to fear. We are all young and can easily limit the mistakes we make by following these credit card habits:
- Do not borrow more cash than you have in the bank. Unfortunately, the money that you borrow on credit cards does need to be paid back. While we would all love an endless stream of cash from the credit card companies, (and unfortunately they are all too willing to give that to you), you will need to pay off your debts. In all likelihood, you do not have any major expenses that would require you to borrow more funds than you can afford. When you first get a credit card, simply use it when you go out to eat, pay for gas, or pick up a few items at the store. You can build credit with these simple payments and a few hours waiting tables can more than likely cover these relatively small expenses. Essentially, you should treat credit like you are paying in cash.
- Make every payment on time and in full. The last thing you want is to start falling behind on your credit card payments. The credit card company will tell you that you only need to make the minimum payment each month, but that is because they want to charge you interest on anything extra. This can be really harmful to your finances because the interest rates that they charge on credit card debt are very high (often 20% or more). To make sure you never miss a payment, you can usually set up automatic payments from your checking account. The credit card company will take the money right out of your checking account even if you forget. However, it is important that you always keep enough funds in the checking so that you are not charged any overdraft fees.
- Don’t use more than 30% of your credit line. This is a smart tip because 1) you do not want to borrow more money than you have and 2) going over 30% may hurt your credit score. Staying below 30% of your credit line should not be difficult for our generation right now.
- Read your account statements. You should not whole-heartedly trust your credit card company. They want to make money off of you, not be your best friend. You should read through your statements and contact them if there are any charges that you do not recognize. Even the multi-billion dollar companies make mistakes and you should not be paying for them. By reviewing your account statements, you can make sure your credit card has not been stolen or used when you did not authorize it.
- Finally, if you make a mistake, fix it. By nature, humans are forgetful. There will be a time when you miss a payment. When you do, don’t be afraid to contact the credit card company. It is likely that they will waive the first missed payment fee, and may even waive a few after that (as long as this is not a consistent problem). There is zero harm in asking, the worst that can say is “no”.
Following these good credit habits will help you build a strong credit history and make you the prime candidate for any loan when you need one. Unfortunately, not everyone has followed these habits and this has led to a credit card debt crisis in the U.S. According to NerdWallet (a great personal finance resource by the way), the average U.S. household credit card debt is more than $6,000. That is a really scary number. However, I am confident that Generation Z can learn from their parents’ mistakes and not fall into the same trap.
Avoid These Pitfalls
Let’s move on to some pitfalls you should avoid to better optimize credit card use. First, having too many cards can negatively impact your score, so stick to the bare minimum you need. Second, choose a card with no annual or hidden fees. There are too many companies that offer their services without fees to choose one that does. If you do choose a card that has a fee, ensure that the rewards are worth the cost. Lastly, if you lose your card, don’t wait to freeze it. Freezing a card will not hurt your credit score, and it is a safe way to make sure no one else uses it. Most companies will allow you to freeze and unfreeze the card instantly either by calling or through a mobile app. Avoiding these credit card traps and you will avoid a mountain of debt and unnecessary fees.
Not All Credit Cards are Created Equal
There are various types of credit cards that fit different individuals. Credit cards can be designed for travelers, students, small business owners, or can be built to give cash back percentages and rewards for people that borrow their funds. The card that I personally use is the “Discover It Student Chrome” Card because it has no annual fee, offers 2% cash back for gas stations and restaurants, 1% for all other purchases, and you can get a $20 credit every year if you hold a GPA higher than 3.0. There are plenty of similar options offered by companies like Capital One, Mastercard, and Citi, so I encourage you to do some comparison research and see what is best for you. If you do decide to go with “Discover It Student Chrome”, send me an email for my referral code and we can both get a $50 credit… just saying.
What if you still don’t trust yourself with a credit card right now?
If that is the case, I would open up what is called a “secured credit card”. This seems very similar to a debit card, but the difference is that you are still borrowing money. Let’s say that you deposit $200 onto this secured credit card, then your line of credit is $200. It allows you to grow your credit score without borrowing more money than in your account. This is another great way to begin building credit, especially early on in your credit journey. Like a regular unsecured card, do your research and make sure that you are using one that works best for you, and avoid annual fees.
Now that you have a better grasp of credit cards, you can decide if you are ready to have one. From my own experience and research, they are essential for reaching financial freedom because having a strong credit score opens many doors. By being responsible with credit cards, our generation can be financially independent and debt-free with no obligations to anyone else besides ourselves.