Obtaining one may be as simple as signing your name on the dotted line of a preapproval form, but a credit card is no small responsibility. Complete with fine print and plenty of penalties, they can be both risky and rewarding, especially in terms of your financial future.
Fortunately, the decision doesn’t have to be daunting. Here are a few ways to gauge if you’re ready.
Do you budget?
A well-maintained budget is just one sign that you might be ready for a credit card.
Not only does budgeting imply that you know how to track past spending habits and use that information to allocate future income, but it can also give you an accurate idea of how much additional income would be available to pay for credit card fees or charges.
However, creating a budget is pointless if you don’t stick to it. By setting a budget with a clear, attainable goal, whether it be for a $5,000 vacation or a $50,000 car, and citing exactly how much should be spent or saved each week to reach that goal, the budget then becomes a guide to manage excess spending and hold yourself accountable.
On the other hand, an obscure or unrealistic budget is mere cause for frustration. Overspending by $5 here or $10 there might not seem to make a difference until it all adds up on paper when the bill comes at the end of the month, especially when using a credit card.
According to Dun & Bradstreet, a leading source of commercial information, consumers tend to overspend by up to 18 percent when using plastic rather than paper.
“Credit cards are best used by those who already have their finances in order,” says personal finance expert Jason Steele.
Conclusion: If you have difficulty sticking to a budget, are unable to control impulse buys or are living beyond your means, then you might not be ready for a credit card just yet.
Do you understand credit?
To many, credit can seem like a complex concept. The effect a credit card, or even simply applying for one, has on your credit can be substantial, so it’s important to first understand how.
You aren’t born with credit, nor is it automatically “given” to you when you are of age. People without a credit history, like those who have never opened a credit card, aren’t likely to even have a credit score or anything to show for on a credit report. This can make initially applying for new lines of credit difficult.
A credit card is one way to establish and–when used wisely–improve credit. It allows you to build a reliable rapport with having an open line of credit, which can be important to prospective lenders for future purchases. For each maxed-out card that carries a balance, the score drops 15 to 45 points, so strive to spend no more than 30 percent of the total credit limit each month and make every payment in full on time.
“People should be largely free of revolving debt and in the habit of paying their bills on time. A credit card is best used as a method of payment, not a means of finance,” says Steele. “Spend only what you can afford to pay in full when your statement arrives.”
It is also not uncommon for errors on a credit report to lower a credit score, often without the consumer knowing. By taking full advantage of the free credit reports from Experian, Equifax and TransUnion available to you once a year, you can proof the reports for errors and track account history.
Conclusion: If you don’t quite understand the basics of credit or fear managing credit would be a challenge, then you might not be ready for a credit card just yet.
Do you really need it?
Convenience is one of the biggest advantages of a credit card. It eases in-store and online transactions, provides a safety net for emergencies and can offer protection on purchases.
But many of these benefits can be achieved without the risk of a credit card.
A debit card offers similar advantages, in an arguably safer way. It can be used for in-store and online purchases, and even looks much like a credit card. However, unlike its card companion, a debit card is typically free of interest and annual or hidden fees. Credit cards balances are unsecured debt, so these rates tend to be higher than on other types of debt, says Steele.
Money spent using a debit card is immediately extracted from your bank account, which means no surprise bills at the end of the month or interest charges on any remaining balance. Many debit cards also offer overdraft protection, so no need to worry about spending more money than you really have–a common credit card pitfall.
Conclusion: A credit card has varying risks and rewards, and it ultimately depends on your unique financial needs. To discuss your credit with a Lighthouse credit expert, call 888-392-7421.
Photo courtesy of 401(K) 2013