Credit cards are convenient enemies. Almost everyone has a bad story about late fees, unauthorized charges, or overspending.
Not surprisingly, many pundits (and parents) have a knee-jerk reaction to credit cards: “Using credit cards is the worst financial decision you can make,” they shout. “Cut them all up!” What an easy battle cry for people who want simple solutions and don’t realize the benefits of multiple sources of credit.
But from one perspective, credit cards are like a delightful gift from heaven.
- If you pay your bill on time, they’re actually a free short-term loan
- They help you keep track of your spending much more easily than cash
- They let you download your transaction history for free.
- Most offer free warranty extensions on your purchases and free rental car insurance.
- But unfortunately, there’s more to them than that.
The truth about credit cards lies somewhere between these two extremes. As long as you manage them well, they’re worth having. If you can avoid the unreasonable fees and tricks, credit cards offer exceptional benefits. To get the most out of using credit, you need to optimize your credit card(s) and use them as a spearhead to improve your overall credit. This is all the more important in the wake of the credit crisis; if you don’t have good credit, it may be difficult to get an affordable home or car loan—even if you have a high income.
Note: Below is an excerpt from the first chapter of my New York Times best-selling book, I Will Teach You To Be Rich.
How to find the right credit card to rebuild your credit
Whether you’ve never had a credit card before or you’re thinking about getting an additional card, there are a few things to think about.
Avoid those credit card offers you receive in the mail. Let’s cut to the chase: If you hate those credit card offers in the mail as much as I do, visit www.optoutprescreen.com to get off their lists. The average American receives twenty credit card offers every year, and four out of every thousand people accept them. The numbers are markedly different for students. Out of every thousand students who are mailed offers, 150 accept them, an astonishingly high number. Students—and young people in general—are especially susceptible to these offers because they don’t know any better. Let’s get real.
Taking a credit card offer you get in the mail is like marrying the first person who touches your arm—99 percent of the time it’s the easy decision, not the right one. Most people know better and go out and find what’s best for them; they don’t just settle for the horrible offers that fall in their lap. For something as important as your credit, make the effort and pick a good card.
There are options if you’re young and/or have no income. Getting your first credit card can be tricky, especially if you’re young. But there’s an easy solution: Get a secured credit card. These are cards that require you to put down a few hundred bucks in a savings account, and then the bank uses that as collateral to issue you credit. After a few months, assuming you’ve behaved responsibly, you can graduate to a regular (“unsecured”) credit card. To get one, call your bank and ask about it.
Avoid cash-back cards, which don’t actually pay you much cash. People get really mad at me when I say this, but cash-back cards are worthless. “Get 1 percent back on all your spending!” Wow, if I spend $2,000 per month on my credit card, I’ll get back $20. “But Ramit,” you might say, “twenty dollars is better than nothing.” Sure, but what if you could save more by getting a free $500 flight? It wouldn’t be as obvious as receiving money each month, but in the long term, you’d save more with a travel rewards card.
Compare cards online. The best way to find a card that is right for you is by researching different offers online (try www.bankrate.com). In most cases, the simplest credit cards are offered by your bank, so this is often a good place to look. They’ll connect with your bank account and you can choose from a variety of options, including credit limit, rewards, and more. On the plus side, they’re easy to get without much research. The downside is that the rewards are usually fairly mediocre.
Rewards are important. You’re going to be using this card a fair amount, so make sure the rewards it offers are something you’ll actually want. I travel a lot, so I got an airline card that gives me free companion tickets, free flights, and points for every dollar I spend and every mile I fly. I get multiple free flights per year, and each one saves me about $350. But if you hardly ever travel, this card wouldn’t make sense for you. Bottom line: If you’re getting a rewards card, find one that gives you something you value.
Don’t go card crazy. Now that you’re in the market, you might be tempted by any number of card offers. But don’t overdo it. There’s no magic number of cards you should have. But each additional card you get means added complexity for your personal-finance system. Two or three is a good rule of thumb. (The average American has four credit cards.) Your credit score is based on overall sources of credit. Remember, there are other sources of credit besides credit cards. These include installment loans (such as auto loans), personal lines of credit, home equity lines of credit, and service credit (such as utilities).
“Take it slow,” Craig Watts of Fair Isaac Corporation says, cautioning against prescribing a specific number of credit sources. “It depends on how long you’ve been managing credit. The less information in your credit report, the higher the prominence of each new report. For example, if you’re in college and you only have one credit card in your name, when you open another account, the weight of that action is more than it would be ten years down the line. If you limit yourself to opening one card a year, you’ll be doing yourself a favor.”
This article originally appeared on I Will Teach You to Be Rich and was written by Ramit Sethi. This is just an excerpt of the original article and we encourage you to visit Ramit’s site to learn more about using credit cards.