CREDIT CARDS: ADVANTAGES AND DISADVANTAGES FOR THE CONSUMER
What are Credit Cards?
A form of money (instant spending power) that provides both the capacity to buy goods and services (i.e., carry out transactions) and the capacity to borrow funds (i.e., gain access to credit).
A Brief History of Credit Cards
The first credit cards, which go back to the Civil War, were used primarily for convenience in carrying out transactions, so people didn't have to always carry cash or a checkbook around. Retail merchants, such as department stores, gasoline companies, and manufacturers, would issue printed or encoded cards to their best customers who would usually pay off their bill as soon as a statement arrived in the mail.
While most early credit cards served a fairly small area and a small number of customers, the idea really began to catch on nationally after the Second World War when oil companies and such prestige card plans as Diner's Club and American Express began in the 1950’s to offer the convenience of charging for purchases (such as restaurant meals) and paying a little later. Still, these were not true credit cards because the customer was usually expected to clean up his or her bill right away. Many experts didn't expect these cards to take off like they did because, at first, few merchants accepted them and many customers didn't appear to qualify for the early plans. However, the tremendous growth of the economy and the great pent-up demand for consumer credit after World War II and The Korean War soon led to the appearance of true credit cards – you could buy now and possibly pay much later (i.e., borrow at least a portion of the purchase price of goods and services charged to the card). These newest cards were sometimes called “credit revolvers” because you could charge up to a certain amount, gradually pay the borrowed amount back over time, and then charge the card up again as long as your account remained in good standing and you did not exceed your credit limit.
Small card companies gradually gave way to larger companies in what turned out to be a high-cost-industry. You needed a high volume of card usage to cover production and capital costs, credit and crime losses, and still make a profit. Such huge industry leaders as BankAmerica Card (later VISA), Discover, and MasterCard eventually emerged from the pack, adding new features as they absorbed smaller companies, such as more generous customer credit limits (i.e., increased borrowing capacity), rebates when the card was used, the ability to return defective merchandise, and insurance coverage for consumers.
By the close of the 20th Century one card issuer, VISA, launched a new variety of card allowing teenagers and other qualified users to spend online the amount electronically entered on the new card, usually by a young person's parent or guardian. However, the parent or guardian setting up this card plan must administer a financial-skills test to young persons given the new card (called Buxx).
Explosive Growth of Cards
Credit card accounts grew rapidly after they first appeared. In fact, by the turn of the 21st Century U.S. banks alone had well over $650 billion in credit card loans. Why did they grow so fast? The principal reasons were:
1. Buy now and pay later (the delayed payment feature that preserves the user's cash for other spending needs).
2. The temporary interest-free loan that a customer has access to even if he or she pays in full a few days or weeks later.
3. Cards are safer than cash (usually a $50 limit on how much you can lose under federal law, and when you notify card issuers of a lost or stolen card, normally you are no longer responsible for unauthorized charges).
4. Cards are accepted almost everywhere today.
5. Cards help out in emergencies (i.e., help to prevent a liquidity crisis).
6. Cards help guarantee reservations when you are especially vulnerable, such as when you are traveling away from home.
7. Cards immediately identify you as a qualified buyer and give you status with merchants and friends.
8. Cards may protect the consumer who receives faulty merchandise (i.e., the customer can delay payment under the terms of many plans until a problem with a previously charged purchase has been worked out satisfactorily).
Potential Dangers and Risks with Credit Cards
1. Consumers may overuse them because they are so “easy” to use and so readily accepted in so many places. Moreover, credit card offers to households have reached record levels in recent years; more than 25 per family per year, on average.
2. Many consumers think of them as extra income, not debt, but debt is what you take on when you use your credit card.
3. Delay in paying can hurt your credit bureau report (credit rating) and make future borrowing more costly as well as create other problems (e.g., in getting a job or qualifying for insurance coverage). Many people don't realize that credit bureaus scattered around the United States and other countries as well usually have a record of every card account as well as any other borrowing that we take on. When we go to borrow more, a lender may see all of the debt we have already taken on and refuse to make us a new loan.
4. Credit cards commit our future income – will our future income be enough? It's easy to get overwhelmed with credit card debt. U.S. household bankruptcies have averaged more than a million per year in every year since 1995. Moreover, most credit card charges (by dollar volume) are for optional purchases, not necessities.
Good Financial Management Practices with Credit Cards
If we are going to be financially successful and learn how to use credit cards without going too far, we need to learn something about personal budgeting. First, each month we need to estimate our “take home” income – what income will be left after deductions for taxes, insurance premiums and other items that normally are automatically withheld from our paychecks? Next, what expenditures for food, shelter, clothing, transportation, medical care, child care, schooling, etc. are we going to have to make? Finally, is there any money left over for savings – be sure to include both emergency savings and long-term savings for retirement, education, etc. Now ask yourself: How would having to pay off credit card balances for items we could do without or paying credit card interest affect our budget? If this amount is too much for our expected net current income, after all living expenses are taken out we need to cut back on credit card usage and limit our charges to a level that our budget can safely handle.
Some Suggestions for Good Credit Card Management
1. Consider using credit-counseling services (especially if you have built up large debts, including credit card obligations; can see no way to pay off those debts given your current income and living expenses; and have no visible prospect of increasing your income in the near future). Counselors help work out budgets and negotiate with your creditors for better terms. Many advertise in the phone book and on the Internet. Ask friends who may have used such a service or get a report on the credit counselors' performance from the Better Business Bureau in your area. Check out what each offers and choose the best counseling service for you.
2. Watch out for “teaser rates” on credit cards that look good today, but can be raised substantially later on. A credit card company could offer you a 5% interest rate today and six months later jump to 15% once you have moved all your debt to the new card.
3. Always read the credit card contract and any mail that arrives from your credit card companies; sometimes the cards' plans terms are changed to include higher interest rates and fees.
4. Be careful with so-called “pre-approved plans” which usually still require you to apply and may wind up giving you a lot lower credit limit than advertised. You can still be turned down even if you are “pre-approved.”
5. Know how interest is assessed against your unpaid card balances: The average daily balance method with a built-in grace period before interest is assessed? The two-cycle method where interest can be charged if you have any unpaid amounts over a two-month period? Or, some other interest calculation method? If you're not sure, ask the credit card company you deal with. They are supposed to explain this, under the law, in simple, straightforward language.
6. Always remember to “shop around” for credit of any kind. Check out several plans; use the Federal Reserve Board's twice-a-year survey to help you find the best credit-card plan that meets your individual needs.
7. Remember that self-control and financial discipline are the keys to successful management. The Greeks of centuries past had a great phrase: "nothing too much." It is well worth remembering if you wish to be a good money manager and enjoy a great life. If you have too many cards or some cards are "maxed out" to their limits, consider cutting up the troubling one and limit your cards to a few (many financial experts recommend holding just 2 or 3 credit cards).
Follow these simple credit card management steps!
• Always pay more than the minimum monthly payment
• Ask the bank to reduce your limit to only what you need
• Take advantage of 0% balance transfer opportunities
• Consider using a personal loan at a lower interest rate to pay off your balance
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