Obtaining a credit card is something of a rite of passage. There’s nothing that makes you feel more adult than digging into your wallet and pulling out a piece of plastic with your own name on it.
But beyond a fleeting moment of accomplishment, is opening an account actually a good idea? That depends on how you use it and whether the card you get suits your particular needs. As many consumers have learned the hard way, it’s a decision that can have long-term consequences. On the other hand, handle it right and it is an important step in starting to build the good credit history that will eventually qualify you for the best rates on car loans, mortgages, and many other financial tools you will need going forward.
Before signing up, make sure you understand what you’re getting into. Here are some of the implications you should consider.
The Pros of Opening a Credit Card
Opening a credit card means getting access to a revolving line of credit from the issuing bank. The account comes with a predetermined credit limit based on the issuer’s assessment of your creditworthiness. As long as your outstanding balance stays within that limit, you can continue racking up charges.
Having that additional payment option in your back pocket has its advantages. For one, you’ll have a safety net in case you face a short-term budget crunch. If you’re strapped for cash and your car needs a new set of brakes, you can simply open your wallet and charge it to your card.
Because most credit card accounts are “unsecured,” they tend to carry higher interest rates than other loans.
Even if you have plenty of funds in your savings account, using a card can be a great way to get rewards. Some products, such as Discover’s flagship card, Discover it®, offer cash-back benefits—typically as a percentage of the amount you charge. And, of course, cards that provide airline miles based on how you spend have long been a popular option among long-distance travelers. In recent years the number of reward programs has mushroomed, with banks offering discounts on everything from hotel stays to NFL merchandise.
If you incur occasional job-related expenses—and don’t have a company-issued card—having a dedicated card for those expenses can be a godsend. It makes record-keeping a whole lot easier, and you won’t have to dig into your personal funds to, say, book a flight to another city for a meeting. Plus, you get to keep whatever rewards you accrue on your personal card.
As long as your employer reimburses you by the due date, you won’t be charged interest. Just make sure you have a clear understanding of your employer’s reimbursement policy. The last thing you want to do is starting paying for lunch meetings that aren’t covered.
Yet another reason to open your first card is to start building a credit history. Without a track record to go on, you’ll be seen as a higher risk when it comes time to take out a car or home loan.
Credit cards report your payment history to the credit bureaus each month. If you’re able to hit your due dates consistently, you can do wonders for your credit score. You’ll do even better if you keep your credit utilization—the size of your balance in relation to your credit limit—fairly low. A utilization rate of under 30% for each account is considered ideal.
The length of your credit history has a direct relationship to your credit score. The longer you hold onto an account, the better it’ll be for your score.
What You Risk When You Open a Credit Card
As convenient as it is to have an extra source of funds at your disposal, credit cards also carry significant potential risks. Most cards are an unsecured form of credit, meaning your debt isn’t backed up by any form of collateral. Because card issuers can’t recoup their expenses if you fail to pay down your balance, they tend to charge higher interest rates than other loans.
That doesn’t matter much if you regularly pay your full balance from your due date. In that case you won’t pay a dime in interest. However, starting on your due date the bank will begin assessing finance charges based on the balance that you’ve carried over.
● Credit cards can help you improve your credit score, but only if you use them responsibly.
● Your payment history and borrowing amount are the two biggest factors in your credit score.
● Secured credit cards are an option for borrowers with a poor credit history.
As of 2018 the average interest rate on cards was nearly 16.8%, according to the Federal Reserve Bank of St. Louis. However, younger borrowers with a limited credit history and those with black marks on their report will often pay in excess of 20%.
The upshot is that you could be paying a lot of money to your issuing bank in finance charges alone. Let’s say you carry an average daily balance of $3,000 and have a 20% annual percentage rate (APR) on your card. You’ll be assessed $600 in interest alone every year. Some cards also charge a flat annual fee that makes them more expensive still.
Avoiding Credit-Card Traps
These days many card companies offer a 0% APR introductory rate in order to entice borrowers. That may sound like a great deal, but in the long run your credit line is anything but free. Once the promotional period ends—generally between nine and 15 months—the real finance charges will kick in. You could suddenly find yourself paying through the nose.
Remember, those interest fees are a primary source of income for banks. Therefore, they have an incentive to keep your balances high (though not too high). How do they do that, exactly? In part by requiring ridiculously low minimum payments each month.
Wells Fargo, for example, sets its minimum payment at $15 or 1% of your balance plus whatever interest you’ve accrued that month, whichever is greater. As long as you pay that amount by the due date, you’re technically making on-time payments. But you pay interest on the entire remainder of your balance—as much as 99% of it—that carries over to the next billing cycle.
That’s only one of the traps that card users can easily fall into. Another is using their cards for cash advances, which are essentially personal loans taken against your available credit. All you have to do is head to your nearest ATM and pop in your card. Suddenly you have a nice stack of cash in your hand.
While a cash advance is certainly an easy loan to get—there’s no additional approval process—it’s also an expensive one. Banks charge a processing fee every time you pull out money, typically 3% to 5% of the advance. They also slap on interest rates that are likely higher than your APR for purchases. Furthermore, that interest normally begins to accrue from the moment you take out money, not from your due date.
If you’re falling short on funds, think about tightening your budget or getting a side job to bring in a little extra money. Credit cards might seem like a nice fix for your cash crunch, but they’ll cost you in the long run through hefty fees and lower credit scores.
The cruel irony of credit cards is that the people who actually need them tend to be most vulnerable to their risks. If, on the other hand, you have the money to pay off your balance every month, the ability to earn rewards and build a good credit history may justify opening an account.
A Safe Way to Build Credit
Customers with poor credit may have trouble qualifying for a traditional credit card. Unfortunately, without a credit account that you use responsibly, it’s hard to get your FICO score back up again.
One solution you might consider is getting a secured credit card, for which underwriting is a lot looser. Unlike with other accounts, the borrower has to make an upfront deposit, which protects the bank in case you default on your debt. In many cases your credit limit equals the amount of your deposit.
As with traditional cards, banks report your payments to the credit bureaus, giving you the ability to raise your credit score over time. And because your credit line is pegged to your deposit, there’s less risk of going off the deep end with your spending.
The CARD Act, a piece of federal legislation that took effect in 2010, curbed the ability of card companies to market directly to college students. The law prohibits on-campus promotions, for example, and requires that applicants under age 21 prove their ability to pay the loan (or at least the minimum payments).
Nevertheless, the fact is that young consumers are still a prime target for card issuers. After all, the first card you get is often the one you’ll use the most. If you’re in that demographic, you’ve likely been hit up with offers through social media or at off-campus events.
As appealing as those offers may sound, be prepared to push back. If you choose to get a card, make sure it’s because you’ve given the matter some serious thought first. Don’t sign up because you’re offered a number of frequent flyer miles or because you’re getting a T-shirt out of the deal. It could end up being a very expensive piece of clothing.
Do some shopping around. Look past the fleeting introductory rate to what the regular APR will be and whether there’s an annual fee. You also want to make sure that the places you shop accept your card network. If you occasionally travel to Europe, for example, you may have better luck with Mastercard or Visa, as fewer places there accept American Express, while Discover is virtually unknown.
And if you’re opening a card primarily for rewards, make sure to read the fine print. Airline-affiliated cards may sound convenient, but it’s worth checking their policy on blackout dates and making sure they fly to your preferred destinations.
The Bottom Line
While there are many good reasons to acquire a credit card, it’s not a decision to take lightly. Opening an account has long-term consequences—and not always for the better. Don't take the first offer you get and do some online research on the options before you choose to sign up. And once you do get a card, manage it like your future depends on how you behave. Because it does.