Personal Finance and Credit Cards - The Worst Mistake

Credit Cards play a big role in your personal finances, and the worst mistake you can make is not understanding them! Understanding Your Personal Finance - Credit Cards is an installment in the Personal Finance series that will help you better understand your finances and the options you have for controlling them and making your money work for you.

Too many people think the concept of credit cards is simple - you buy on credit, and you pay it back with monthly payments. This  is the worst credit card mistake you can make, and this understanding has so many hidden pitfalls that it has led to the creation of a new mutli-billion dollar industry - Credit Card Debt Repair Services!

Do you really understand credit cards and their impact on your personal finances?

Not understanding your credit cards is the worst mistake you can make, but it is a broad definition. Here are some of specific mistakes. Source (Creditcards.com)

1. Having too many credit cards - hurts your credit score, and financial discipline
2. Misunderstanding the introductory rate - your introductory rate period will expire then what will your real rate be?
3. Not reading the fine print - consumer laws require that credit card issuers tell you about all their terms, in print, it's just up to you to read them

These were just a few of the main mistakes listed, but you can see they all relate to not understanding your credit cards.

Contrary to the old adage, with credit cards - what you don't know really can hurt you! Do you understand your credit cards?

Do you know if your credit card agreement, ( the contract you sign), allows your interest rate to jump to as high as 29.5% instantly?

Do you know if you can be charged a penalty fee if you pay-off your credit card early?

Do you know if you gave your credit card issuer permission to share or sell your personal information?

• A consumer credit card literacy survey by Creditcards.com found that 4 out of 5 American credit card consumers cannot read and understand the "fine print" of their credit card contract they signed to get the card
• Credit card contracts have the potential to be filled with so many practices that are detrimental to consumers, or so convoluted in explanation, that in 2009 a Federal Law was passed to force changes to make credit card terms more fair and understandable

Smart credit card usage should never include long-term debt obligations. That is a financial trap that smart personal finance planners avoid, but still:

• 92% of college undergraduates admit to using credit cards for some educational expenses, even tuition, and the average college graduate will leave college with over $4000 in accumulated credit card debt - (Source: Sallie Mae, "How Undergraduate Students Use Credit Cards: 2009")
• Almost half of a minimum monthly credit card payment goes to pay just the interest payment! A $1000 CC debt, at minimum payment of $30 monthly, (3% of balance), would take 112 months, (over 2 yrs.), to pay off, and you would pay over $923 in interest alone
• As of March 2010, the average household credit debt was over $15,000! And amounted to over one-fifth of their total debt obligation! (Source: Federal Reserve's G.19 report on consumer credit, March 2010)

The point of the above information is that credit cards are tools. Use them responsibly and they will be an asset in your personal finances, use them irresponsibly and they will become a huge liability and burden.

Credit cards also play a large part in determining your credit score. (more on that later)

There are two basic types of Credit Cards: Secured and Unsecured.

• Unsecured Credit Cards are the most common, and are referred to as standard credit cards. Unsecured simply means you get the card based on your promise to repay the money for whatever you use it for. You need a good credit history and credit score to qualify for an unsecured card.

*Standard credit cards come in many flavors; low-interest credit cards, balance transfer credit cards, "rewards program" credit cards, airline and company-branded credit cards.

• Secured Credit Cards require that you deposit an amount of money as collateral before you can get the card, and the card's credit limit is directly tied to the amount you deposited. This type of card is generally used by people with no, or bad credit, and is frequently a first step on the road to credit repair, or establishing a credit history.

Then there is the obvious distinction of personal or business credit cards. *Business credit cards may be issued under an individual or business credit history

There are some basic credit card details you need know before you can make intelligent choices about managing or getting credit cards.

A credit card is nothing more than an instant loan machine! When you use it, the card issuer is "loaning" you the money for your purchase - they just pay the merchant instead of giving you the money. Do you really want to "take out a loan" to go out to dinner?

Contract terms: This is important! When you sign an agreement to accept a credit card you are signing a legally binding contract! Your credit card agreement spells out all the terms and conditions you are bound by when you accept the card, and these conditions are not always obvious, or easy to read or understand.

Fees:

• Annual Fees - Some credit cards charge a yearly fee just to have the card. Annual fees range from $18 to $150
• Late Fees - Miss a payment deadline and you will probably be charged a late fee. late fees average about $28, but could be as high as $39 (Source: Consumer Action credit card survey, July 2009)
• Over-limit fees - Exceed your credit limit on a card and you may be charged an over-limit fee averaging about $39 (Source: Pew Safe Credit Cards Project, March 2009)

Interest Rate:

• Over 93% of all credit card agreements allow your interest rate to be changed anytime the card issuer wants! Do you know your current interest rate? 36 percent of survey respondents said they didn't know the interest rate on the card they use most often. (Source: FINRA Investor Education Foundation, "Financial Capability in the United States," December 2009)
• Promotional interest rates of 0% to 4% are typical for new card offers, but beware the fine print! They are usually for a limited time, (typically 1 year), miss one payment or exceed your credit limit and they could jump to as high as 29% instantly
• The average fixed-rate cards charge around 10%, and variable rate cards are around 13%. But ... the average APR rate is almost 15%! Do you understand the difference? (Source: Consumer Action credit card survey, July 2009)

**APR stands for “annual percentage rate.” It is not actually a number that affects the cost of your loan, (which is what happens every time you use your credit card, the card issuer loans you the money for the purchase), but it is a number that includes various rates that you may inccur by using your card. That is why the APR rate is usually higher than the quouted interst rate.

Rewards: About half of credit cards now have rewards programs. Card usage rewards can range from cash-back percentages to rewards points to airline miles, and a card's rewards program is the second most important consideration for people choosing which card to get or use. (Source: Aite Group survey, January 2008)

• Caution - almost all rewards programs have restrictions. Be sure you read your agreement to be aware of the details of your rewards program. You may be required to spend a monthly or quarterly minimum to qualify for the rewards.
  
• Just like card interest rates - rewards programs can be changed any time the card issuer wants, regardless of the terms of the initial agreement

Summary: Credit cards are loan machines! Consider how much thought you would give to agreeing to a new mortgage or car loan, do you give the same consideration when you pull out your credit card to pay for dinner? It's the same thing - you are accepting a new loan.

Once you understand that a credit card is just a handy tool - a way to finance your purchases, and you understand the basics of a credit card agreement, then you can make smarter decisions about what credit cards are a good fit for your personal lifestyle, and which cards work with your personal financial goals.

• Picking the Right Credit Cards
  

Picking the right credit card to use and managing that use is an important part of your personal finance. See how you can make the right credit card decisions to match your personal financial goals.

Understanding credit cards and your personal finance is part of an understanding finance series that is intended to provide personal finance basics well before you have to get involved in the concept of financial planning, financial planners or consultants, and also provide the foundation for understanding the financial retirement investment decisions that must be made to ensure you are on the right track for your retirement planning. creating a financal plan requires you have an understanding of a lot of financial concepts, including credit card management.