There are all sorts of crazy urban legends and unfounded myths out there that never seem to be debunked. Fortunately, none of them have to do with personal finance, right?
If you’re like many modern consumers, and you consider yourself one of the many responsible spenders and savers in this world, you’re probably correct in thinking that your credit card is a pretty straightforward piece of plastic, immune to any sort of falsehood or misconception about how to use them.
Unfortunately, that’s not always the case. As credit card debt crept over the $700 billion mark last year, it’s apparent that we surpassed our credit limits big time — and part of it could be a lack of awareness to some of the common (and uncommon) credit card myths that so often get overlooked.
In honor of Financial Literacy Month, here are some basic credit card facts vs. fictions to consider so your finances — and your credit standing — will stay in good shape no matter what month it is.
1. Debit and credit cards both improve your credit score.
They may look alike, bear the same logos, and are both used to buy stuff with, but that’s where the similarities between debit cards and credit cards end.
A debit card has no bearing on your credit score, since all purchases made with the card are automatically deducted — or debited — from your checking account. Credit cards, on the other hand, operate on the principle of borrowing against the credit card company, and paying them back. How timely you pay your credit card bill each month goes into determining how reliable of a borrower you are, and thus, what your credit score will be.
That’s not to say you shouldn’t opt for a debit card for everyday purchases, but keep in mind that you could actually be harming your credit score by failing to maintain a regular credit card use. Spending habits limited to a debit card won’t get reported to the credit bureaus, which may result in a big fat zero on your credit report since you’re not using your credit card.
2. I only need to pay my minimum balance.
It really should be a no-brainer: your credit card balance is not paid off until it’s paid off in full. But many consumers believe that by paying their minimum balance (according to the Wall Street Journal, typically 4 percent of the total credit card balance), they’ll owe no interest on the remaining balance.
This is one way credit card companies earn their money, getting customers to maintain debt while charging them exorbitant interest rates on the remaining balance. It can become an endless cycle of outstanding credit card debt that never gets resolved. Even if your minimum balance came to $25 one month, paying that small amount will keep you in the good faith of TransUnion, Experian and Equifax. Neglecting to repay the remainder of what you owe on your credit card balance, however, will turn that around pretty fast.
3. A credit self-check will harm your credit score.
A cautious issue especially for people looking to rebuild their credit — the last thing a person with poor credit needs is to worsen their score through a simple credit check.
But not all credit checks are made alike. It is true that your credit score can take a hit when a lender, bank, or other financial institution makes an inquiry; these "hard" looks into your history can bring it down a few points. But checking your own credit score won't affect it at all — that would be like losing cash each time you looked at your checking account balance.
4. No credit limit? Spend away!
Many "exclusive" credit cards (think of those emblazoned with marketing buzzwords like Gold, Black, VIP or Signature) don't disclose their spending limits. It can lead card holders to think that they can rack up as much as they like on their accounts. While they're wrapped up partaking in some serious conspicuous consumption, sooner or later their cards will be declined once they've maxed them out. What was that sound? Your credit score being knocked down several points.
The truth is that every credit card has a spending limit. Some are higher or lower than others. What the myth doesn't tell us is what the credit card companies aren't telling us — that non-disclosure of their NPSLs, or Non-Preset Spending Limits, is a way to attract more customers into thinking their credit card is better and more exclusive. In the end, even the best credit cards reach a spending limit, and it's up to you to pay it back.
5. Fixed interest rates are just that.
This can be a tricky one. While it's true that a better credit history locks you in to a better (i.e. lower) interest rate, nothing is set in stone.
Part of it has to do with regulations set forth by the CARD Act, which placed limitations on how creditors can raise fixed rates. Normally, your rates can become variable depending on the type of borrowing you put on the card. For instance, if you use your credit card to withdraw cash from your account, your interest rate could climb sky-high.
Moreover, it goes without saying that late payments — or, even worse, partial payments — on your credit balance are worse than missing a payment. In this case, many credit card companies will impose a penalty interest rate, which can be as high as 30 percent in some cases.
6. Why can't I put this $2 purchase on my credit card?
The truth is, you should be able to. Retailers and store merchants technically aren't allowed to set a minimum amount you can charge to your card, but we've all been there. How many times did you get to the front of the line with a $1.50 Pellegrino only to read the sign that says, "$7 minimum credit card purchase"?
Credit card experts maintain that each credit card transaction can cost a retailer 2 percent of the total sale — not very much, but for the small business person, it can add up. Simply put, retailers also want to make their credit card charges worth their while by getting you to buy more when faced with that minimum charge amount.
Technically, this is an illegal practice. Surprisingly, though it's not something that's enforced by credit card companies, so the best customers can do if they object is to take their business elsewhere, or carry cash, which defeats the purpose of having a credit card in your wallet.
7. $25,000 credit limit = What I can comfortably afford.
Maybe so, but credit limits are different for each person. Credit card companies traditionally determine their credit limits based on a person's spending history and bill payments; through that, a specific dollar amount is assigned. But creditors don't know everything, mind you, like what your monthly budget is, how much money you've got in the bank at any given moment, or what you can really afford from month to month.
Creditors also make use of a term called "low utilization," which means that using a smaller amount of credit in your account looks better to the credit bureaus, and subsequently, your credit score. Just because a credit limit is set as high as your annual income doesn't mean it's meant to be maxed out.
Wise spending on credit is good not just for your credit score, but your overall financial standing. If you've got dollar signs in your eyes and you're tempted to spend freely on your credit cards, take the time to understand some simple misconceptions about credit cards. It'll help you make more financially literate decisions the next time you swipe that card — and your credit card will thank you for it.
Paul Sisolak writes for www.GoBankingRates.com, which provides readers informative personal finance and investing content, as well as the best interest rates on financial services nationwide.