Credit cards can be a dream come true — or a nightmare – for your finances, and it all depends on how you use them. If you use credit for the perks and rewards without ever carrying a balance, for example, a bounty of benefits can be yours for free. But, if you use credit without a plan — and to buy things you can’t really afford — you could spiral into a lifetime of debt and regret.
So, how do you access the benefits of credit cards without dealing with the downsides? The answer is simple: You use credit with a plan and with complete awareness of the pitfalls you’ll face if you get off track.
In other words, use credit cards to buy items that are already budgeted for — items you have the cash to pay for. Also, make sure you pay your balance in full every month (or possibly even weekly) so you never have the chance to get off track.
The pros of using credit cards can outweigh the cons and risks if you’re disciplined with your spending and able to track it faithfully. Here are six of the benefits you could score if you use credit responsibly, plus six things that could go horribly wrong.
Benefit #1: You could earn rewards on your spending.
One of the biggest benefits credit cards offer is the potential for rewards, whether that means cash-back, airline miles, hotel points, or flexible travel credit. Many credit cards offer up to 5x points in certain categories, which means you could benefit handsomely if you use your card for regular purchases.
Pitfall: You could wind up buying things you don’t need to earn more rewards.
Unfortunately, far too many people spend more than they should to chase points and miles. Keep in mind that you’re not really benefiting from credit card rewards and cash-back if you are overspending to rack up points.
Benefit #2: You could access free travel insurance coverage.
Some credit cards — and particularly travel credit cards — offer free insurance coverage such as travel accident insurance, trip cancellation/interruption insurance, and baggage delay insurance to cardholders for free. All you have to do to access this free coverage is use the card that offers it when you pay for your travel expenses.
Pitfall: You could arrive home from vacation to a huge credit card bill.
Charging travel to a credit card can help you access important insurance coverage, but you must make sure you have the cash to pay your balance in full. Remember that the average credit card interest rate is now over 17% according to Bankrate, and you can see how this “free coverage” could become costly if you charge vacations you don’t have the money to pay for?
That weekend in Bali? You could wind up paying for it for years.
Benefit #3: Protect yourself with zero fraud liability.
Most credit cards offer zero fraud liability coverage that protects you if your card or card number is lost or stolen. If someone uses your credit card for fraudulent purchases, you won’t be on the hook for a single penny of those charges.
Pitfall: You might be tempted to take out a cash advance.
On the flip side, credit cards can make spending and accessing cash a little too easy. Many credit cards even let you take thousands of dollars out of an ATM via a cash advance in exchange for high fees and interest charges that start on day one.
If you’re worried you’ll be tempted to take out a cash advance, you’re better off keeping your credit card out of sight and out of mind. Better yet, avoid using credit altogether.
Benefit #4: Get an interest-free loan.
Credit cards offer a billing cycle and a “grace period” that lets you avoid paying interest provided you pay your balance in full every month. In that sense, you can use them for a quick, interest-free loan that lasts a few weeks. Some 0% APR credit cards even offer zero interest on purchases and/or balance transfers for up to 21 months, although some of these cards also charge a balance transfer fee of 3% to 5%.
Pitfall: You might get too comfortable making the minimum payment.
Getting an interest-free loan is great, but what happens if you don’t want to pay it off as fast as you should? Credit cards offer minimum payments that can make it far too easy to pay a little and worry about your huge balance later.
Benefit #5: Get access to an emergency line of credit.
Many consumers use credit cards for emergencies, which can be a good or bad deal depending on how savvy you are. It can be smart to use credit for true emergencies you can afford to pay off within a few months, but it is wise to have an emergency fund with 3 to 6 months of expenses as well.
Pitfall: You could start treating your “wants” as emergencies.
Covering a surprise medical bill or an emergency roof repair with credit when you can pay it off in a few months is one thing, but what happens when nearly everything you want seems like an emergency? If you start charging hot tubs, clothing, and dinners out with friends to your credit card, you could be in for a world of financial hurt in a hurry.
Benefit #6: You can build credit.
Credit cards offer one of the easiest ways to build credit. They are easy to sign up for online, and your payments are reported to the three credit reporting agencies — Experian, Equifax, and TransUnion — each month. With responsible credit use, you can use a credit card to build up your credit report and score over time.
Pitfall: You can also hurt your credit.
Keep in mind, however, that credit cards won’t help your credit if you use them haphazardly. Late payments can hurt your credit score in a big way, as can running up large balances and applying for too many cards at once.
You can use credit in your favor, but it can just as easily work against you. As with anything else in life, the choice is yours.