Credit cards can be indispensable financial tools, but you may be receiving mixed messages about how to use them wisely. Consumer knowledge about credit is on a significant decline, according to a survey from the Consumer Federation of America. Only 66% of survey participants, for example, know that keeping a low credit card balance helps raise a low score or maintain a high one, while 85% knew this in 2012.
To help clarify fact from fiction, here are five of the most common credit card myths—debunked.
Myth #1: You only need one credit card
Reality: It’s always wise to apply for credit judiciously, of course, as applying for multiple cards in quick succession can cause your credit score to drop. But if you already use credit responsibly, there are valid reasons why having more than one card might make sense. Here are three to consider:
- You’ll have a backup. What if your credit card becomes compromised due to fraud or is declined? Having another card on hand can provide backup and give you peace of mind. Plus, having an additional card means you’ll have an option if a merchant doesn’t accept the one you carry.
- You can maximize rewards. Another benefit of carrying more than one card is taking advantage of rewards plans that fit your spending patterns. For example, you could use a card that offers the best grocery rewards to do all your food shopping, use a top-rated travel rewards card to book Airbnb reservations, or use a designated card only for reimbursable job-related expenses.
- You can better manage debt. Different credit cards have different purposes and choosing one that helps you meet financial goals may provide important advantages. For example, as an NEA member, you may choose to apply for the NEA RateSmart® Card which can help you save on interest and pay down debt when you transfer higher-rate balances.
Myth #2: Making the minimum monthly payment is enough
Reality: Last year, 35% of adults surveyed for the FINRA Investor Education Foundation’s latest National Financial Capability Study said they paid only the minimum payment (typically between 1% and 4% of your balance) on their credit cards in some months. The problem? The higher the balance you carry from month to month, the more interest you pay. And that’s money you could be saving or using for other things.
What’s more, if you continue paying only the minimum repeatedly, the interest compounds. Let’s say you have a credit card balance of $7,800 with an interest rate of 15%. You’re currently making a payment of $234 each month, which is what the 3% minimum payment was in the beginning. It would take more than 3 1/2 years (44 months, to be precise) to repay that debt entirely—plus you’d end up paying $2,353 in interest, according to a calculator from Credit Karma.
Ultimately, there’s only one guaranteed way to avoid paying interest on purchases. If possible, pay off the balance every month.
Myth #3: All rewards programs are the same
Reality: No single rewards card is a perfect match for everyone.
Rewards credit cards essentially come in two flavors: cash-back cards and travel cards. Cash-back cards pay you back a percentage of each transaction—usually between 1% and 6%. Travel rewards cards, on the other hand, give you points or miles for each dollar you spend. The points are redeemable for airline flights or hotel stays, among other things.
Around 33% of credit cards with rewards give cash back, while 63% provide points or miles, according to a recent WalletHub analysis. And each card comes with various caps, expirations, rebate levels, sign-up bonuses and spending categories.
What’s the best way to make cards with perks work for you? Decide exactly how you plan to use them. Here are two factors to consider:
- Estimate the true value. Assess the likelihood of what the rewards you expect to receive (and will actually use) are worth each year, compared to the annual fee you must pay.
- Customize rewards based on your needs. Earning cash back on categories that match your spending makes financial sense. That means it’s wise to look for flexibility.
Here’s an example of that kind of flexibility. With the NEA® Cash Rewards Card, available to NEA members, you can tailor your rewards based on your personal situation and spending plans. You can earn 3% cash back in any one of six categories—gas, online shopping, dining, travel, drug stores, or home improvement/ furnishings—and you can change the category once a month. Plus, you’ll earn 2% cash back at grocery stores and wholesale clubs, and 1% on all other purchases. You can earn 3% and 2% cash back on the first $2,500 you spend in your combined choice category and grocery store/wholesale club purchases each quarter.
Say you’re planning a vacation road trip during the last part of summer break and anticipate dining out a lot more. You could choose to earmark your future 3% rewards for the month to the “Dining” category to maximize your cash back.
Myth #4: A high credit card limit is a bad thing
Reality: On the contrary, having a higher credit limit that’s managed appropriately may have a positive impact on your credit score.
In most cases, a higher limit indicates that credit-reporting agencies consider you a favorable risk. But if you routinely use a large percentage of your available credit, they may interpret it to mean just the opposite—that you’re overextended—and a less favorable risk. Up to 30% of your credit score is based upon the amount of credit you have versus the amount you’ve used, which is known as the “credit utilization ratio.” The ratio compares the amount of credit you’re using on your cards to your overall available credit. The more credit you have and the less of it you use, the better your score.
As a guideline, experts often recommend using 30% or less of available credit to show that you can keep your balances low in proportion to your overall credit limit. For example, if your credit limit is $5,000, you’d want to try to keep an average balance of no more than $1,500.
This will become especially important starting the summer of 2020, as FICO has announced that it will apply new credit scoring models then that are expected to positively impact—by as much as a 20 point increase—those with a score above 680 who continue to make on-time payments and use 30% or less of their available credit each month, according to Debt.org. Conversely, those with a score under 680 who miss payments and spend close to their credit limit each month could see their scores drop by as much as 20 points. The new scoring system will also take into account your historical usage of credit. If you have steadily reduced debt over the last two years, your score should go up. If you’re steadily adding debt, it may drop.
To help lower utilization, if you’ve had a credit card for a while and have demonstrated consistent, on-time payments while staying at 30% or less of your available credit limit, you may want to ask the credit card provider to raise the limit.
Myth #5: You need to carry a balance to build credit
Reality: According to a survey from CreditCards.com, 57% of cardholders have carried a balance on their account before, and more than 20% believe that carrying a balance will improve their credit score. This is incorrect. In fact, having high outstanding debt can negatively affect your credit score.
To build a healthy credit history, pay attention to the factors that go into calculating your credit score. Components of a FICO® Score, for example, are divided into five categories: payment history (35%), amounts owed (30%), length of credit history (15%), new credit (10%) and credit mix (10%).
In general, having credit cards, making payments on time and limiting credit utilization will all help build your credit scores. Someone with no credit cards, for example, tends to be viewed as higher risk than someone who has managed credit cards responsibly over time.
Build credit success
As you explore credit card options, consider leveraging current connections. Depending on the reason for adding a card, for example, you may want to start comparison-shopping with your current card provider, bank, credit union or professional membership group. Why? Your existing relationship may qualify you for a better offer.
You can learn more about choosing a credit card and discover NEA-member cards that offer competitive rates and rewards here.