- Credit cards can help you build credit, earn rewards and cash back, and have more flexibility in how you pay for expenses.
- But credit cards can also charge very high interest rates and can potentially hurt your credit if you use them improperly.
- It’s important to weigh the pros and cons of credit cards to see how they might fit into your personal finance strategy.
Credit cards are a very common personal finance tool. In fact, 83% of American adults had a credit card in 2022, according to data from the Federal Reserve. But there are pros and cons of credit cards to be aware of.
Credit cards can offer a variety of great benefits and help build your credit history. But they can also lead to very expensive credit card debt and even hurt your credit score. It all depends on how they are used.
In this article, we’ll quickly review how credit cards work and then take a look at the key pros and cons of credit cards.
First, let’s briefly look at how credit cards work.
Credit cards are a credit (AKA debt) product that allow you to borrow money and repay it later. However, they work differently than a standard loan because they are a form of revolving debt. This basically means that you can borrow and repay continuously, and that the amounts you borrow and repay may fluctuate.
Here are some of the basics about credit cards:
Now that we have the basics covered, let’s dive into the credit card pros and cons that you need to know.
The specific advantages of credit cards and disadvantages of credit cards can vary depending on the specific card you get as well as how you use the card. But overall, these are the key pros and cons to be aware of.
As mentioned, when you use a credit card, the credit card issuer will report your activity to the credit bureaus. Over time, this will help build up your credit history. And if you pay on-time and don’t use too much of your available credit, using a credit card may help you improve your credit score.
If you miss payments, pay late, or use too much of your available credit, this can actually hurt your score. In addition to paying your credit card on time, you should aim to keep your credit utilization below 30% (which means if you have a $1,000 credit limit, try not to carry a balance of more than $300).
One of the major pros of credit cards is the ability to earn rewards. A rewards credit card may offer cash back, airline miles, or points in a flexible rewards program. For instance, a card might earn 1.5% cash back on all purchases. This means that if you spend $100 using the card, you would earn $1.50 in cash back.
Credit cards may come with annual fees, which can be anywhere from $95 to over $500. This annual fee is charged regardless of how you use the credit card. While these fees may be worth paying if you can utilize the card’s benefits, it’s important to understand all the costs associated with a card.
With a credit card, you have some flexibility in how and when you repay your debts. You’re only required to pay the minimum payment each month, which may be a set amount or a percentage of your balance.
For example, let’s say you spent $550 on your credit card in a month, you may only have to pay $35 by the due date. This gives you the flexibility to choose how much you can afford to pay back between $35 and $550.
If you pay the full balance before the due date, you won’t owe any interest. If you choose to carry a balance, you will pay interest.
One of the biggest cons of credit cards is their high interest rates. When you carry a balance from month to month, you will owe interest on your balance.
In addition to high interest rates, credit card interest compounds. That means the interest charges become part of your balance, and you can accrue interest on your interest. For example, if you have a $1,000 balance and are charged $20 in interest. Your balance becomes $1,020 and that new balance will be charged interest if it’s not paid off.
This is why it’s so easy to fall into credit card debt if you’re unable to pay your balance in full each month.
Beyond the rewards you earn, many credit cards also have other perks. This can include fraud protection, purchase protection, travel benefits, extended warranties, and more. Each card offers different benefits, so be sure to read the fine print.
Credit cards allow you to spend more money than you have. While useful for making large purchases, this can also lead to costly credit card debt. By contrast, when you use a debit card or cash, you can only spend money that you already have, eliminating the temptation to overspend.
Travel credit cards can be very useful for frequent travelers, offering perks like rental car insurance, no foreign transaction fees, airport lounge access, and the ability to earn airline miles or other travel rewards.
Some cards have annual fees, as mentioned above. Beyond that, credit card companies will charge late fees for missed payments, cash advance fees, balance transfer fees, authorized user fees for adding additional cardholders, and more. Make sure you're aware of the costs of your credit cards features and services.
Ultimately, the pros and cons of credit cards really vary depending on how you use your credit. If you pay on time and pay off your full balance, you can earn rewards and build credit without accruing interest. But if you carry a balance you could pay a lot of interest, and if you miss payments, your credit score can be affected negatively.
*Earn 3% when you spend at least $4,000 in a billing cycle, 2% when you spend at least $1,000 but less than $4,000 in a billing cycle and 1% when you spend