1. Credit And Debt Management: Introduction
  2. Credit And Debt Management: Credit Reports And Scores
  3. Credit And Debt Management: Building Credit From Scratch
  4. Credit And Debt Management: Repairing Credit
  5. Credit And Debt Management: Credit Cards
  6. Credit And Debt Management: Reducing Debt
  7. Credit And Debt Management: Debt Collection And Bankruptcy
  8. Credit And Debt Management: Credit Counseling
  9. Credit And Debt Management: Credit And Relationships
  10. Credit And Debt Management: Conclusion

by Cathy Pareto

Credit cards offer a convenient way to purchase things without the hassle of carrying cash. Used wisely, they're a great way to defer payment on purchases for roughly a month. Additionally, many lenders offer incentive or rewards programs for every dollar you spend on your card, which many credit consumers find convenient. One could argue that credit cards, provided that the consumer exerts discipline in the way the cards are used, are an excellent tool and provide an effective way to manage cash flows.

But credit card usage should encourage healthy spending habits, not irresponsible ones. It's easy to fall into the trap of buying things you cannot afford and allowing your wants to trump your needs. Remember that high outstanding debt on credit cards or other revolving debts can adversely affect your score. (Find out how to make your credit cards work for you - not against you - in Get A Free Ride From Credit Companies and Credit Card Perks You Never Knew You Had.)

How to Get Into Trouble With Credit
The following is a list of surefire ways to get into credit card trouble:

  • Relying on your credit card to afford necessities (ex. gas, groceries).
  • Playing financial gymnastics (using debt to pay other debt).
  • Spending money you do not have or living a lifestyle you cannot afford.
Further, behavioral finance studies have demonstrated that people are willing to spend more for the same good or service bought on credit than with cash. (To learn more about how to manage your plastic responsibly, read Six Major Credit Card Mistakes and Take Control Of Your Credit Cards.)

Making Money on Your Bad Decisions and Misfortunes
Credit card companies hate it when their customers pay their bills in full every month because it gives them little opportunity to make money. This type of customer is known (ironically) as a "deadbeat", because creditors make the least amount of money from them. Meanwhile, creditors use the term "revolvers" for the more than 50 million Americans that carry balances from month to month, racking up handsome fees for the credit card companies. Credit card companies bank on consumers' inability or unwillingness to pay off their purchases every month.

There are two ways credit card companies compute the interest they charge you. One is more costly to you than the other, so it's worth being informed. The first method used is the average daily balance method. This is the best method for many consumers because payments on the card lower the interest payable immediately. With this calculation method, if you had a balance of $1,300 for the first 16 days of the cycle, then a balance of $1,000 for the next 15 days of the cycle, your average daily balance would be calculated like this:

($1300 x 16) + ($1000 x 15) / 31 days = $1,154.84 average daily balance

The second method is called the two-cycle average daily balance method. This method takes into account the average daily balance from both your previous statement and your current billing cycle, which may potentially lead to higher finance charges. Using the previous example, if your average daily balance was $1,154 in the previous cycle and $600 in the current cycle, even though you have paid down a good chunk of your balance, you would pay interest on $877, not $600. Here's how your credit card company would calculate it:

($1,154 + $600) / 2 months = $877

Other Credit Traps to Avoid
While a good portion of creditors' revenue comes from the interest they charge consumers on outstanding balances, they also make money from annual fees, late charges, over-the-limit charges and merchant fees. Consumers nationwide have been burned by excessive fees, grossly high interest rates and credit terms that seem to be charged at the whim of the credit card companies.

Consumers should also beware of convenience checks and cash advances from credit card companies. There can be huge differences in the interest rates and transaction fees associated with these types of credit events, and the card companies make a bundle on the use of these options. If you're being charged $5 to take out $20 on your credit card as a cash advance, plus paying interest on this $25, you can see where you are the big loser in the payment scenario.

Another area where credit cards trap consumers is the shrinking grace period. It used to be that people had 30 days to pay their credit card bills, but the average grace period has shrunk to 23 days.

College Students and Credit
Another way credit card companies make money is by luring young and financially unstable prospective customers with arguably deceptive and targeted offers like teaser rates or gift items. University students are particularly vulnerable to this trap, since credit card representatives often man tables in university student centers, offering giveaways for students who apply for cards on the spot. Teaser rates especially seem to shock these new consumers. Many card companies incentivize the consumer to open an account because of a low interest rate, and then later the consumer finds that the rate has skyrocketed. Before you open any card, be sure to read the fine print so you can avoid any unhappy surprises like this. (For more on reading the fine print, see Watch Out For Changes In Credit Card Agreements.)

Credit cards offer obvious advantages to cash-strapped college students who may lack the money to pay for day-to-day expenses. After all, it's easier for them to spend on plastic if current cash flow is a challenge. If used responsibly, credit cards can allow students to build up positive credit histories that will increase their access to credit in the future. However, if college students have failed to learn sound financial management skills from their parents or from formal training in high school, the disadvantages of credit cards can outweigh the advantages.

Here are some interesting facts about students and credit cards:
  • Nearly 67% of students report owning at least one credit card.
  • Of the students with cards, about 65% pay their bills in full every month, which is higher than the general adult population.
  • The average undergrad has $2,200 in credit card debt.
  • The average young adult who carries credit card debt spends nearly 24% of their income on debt payments.
  • According to a U.S. Public Research Interest Group study, 76% of students in the study claim that they stopped at credit card marketing tables on campus to apply for their cards, and nearly one-third were offered gifts as an incentive to sign up.
If you're one of the many who carry a balance from month to month, the next section, will discuss strategies for reducing your debt.

Credit And Debt Management: Reducing Debt
Related Articles
  1. Personal Finance

    Best Credit Card Features For Students

    Students should look for credit cards that charge no annual fees, have a low introductory interest rate and offer rewards or money.
  2. Personal Finance

    How Many Credit Cards Should You Have?

    National stats indicate most consumers have three or more cards - are you one of them?
  3. Personal Finance

    Take Control Of Your Credit Cards

    The plastic in your wallet doesn't have to hurt your finances. Learn how to manage it responsibly.
  4. Personal Finance

    How To Get Your First Credit Card

    Here's a rundown of how you can go about getting your first credit card.
  5. Personal Finance

    Why More Millennials Need Credit Cards

    Here's why more Millennials should have credit cards – even though a majority don’t.
  6. Personal Finance

    How Many Credit Cards Should You Have?

    Having several credit cards provides many benefits. Here are a few factors to consider when you’re deciding how many credit cards you need.
  7. Investing

    Investing In Credit Card Companies

    This investment requires keeping an eye on consumer indexes and the overall health of the economy.
  8. Personal Finance

    Credit, Debit and Charge: Sizing Up The Cards in Your Wallet

    Not all plastic is equal! Learn the difference between the three kinds, and how each can affect your finances.
  9. Personal Finance

    Terrible Credit Score? Try These Credit Cards

    When your credit is less than stellar you have fewer choices. But some are still better than others. Here's our read on which cards to get.
Frequently Asked Questions
  1. What's considered to be a good debt-to-income (DTI) ratio?

    Your debt-to-income ratio helps lenders determine your credit worthiness. Find out how to calculate your score and how to ...
  2. What is the difference between a loan and a line of credit?

    Learn to differentiate between lines of credit and standard loans, and determine when you are likely to use each method of ...
  3. What does a Chief Financial Officer (CFO) do?

    A CFO is responsible for accurate reporting of a company's financial information, investing the company's money and identifying ...
  4. How did George Soros break the Bank of England?

    George Soros pocketed $1 billion by betting against the British pound, cementing his reputation as the premier currency speculator ...
Trading Center