The Wall Street Journal Guide to Starting Fresh is a great how-to guide for people starting over after a financial setback like a job loss, divorce, or death of a spouse.
In it, author Karen Blumenthal shares four really costly misconceptions about credit cards:
- You only need to pay the minimum each month – Paying the minimum payment (typically 2-4% of your total bill) will keep your account in good standing, which will help your credit score. But if you pay only the minimum, you’ll still be paying interest on the entire balance that is owed. If you got a great low rate, that might not be so bad, but if you’re paying the standard credit card interest rates – which are among the highest we’ve ever seen, you’re barely making a dent in your principal by making the minimum payments, and you could get into a situation, if you go long enough, where you end up paying interest not just on what you owe but on your interest payments too.
- Your credit limit reflects what you can afford – I definitely believed this myth when I got my first credit card as freshman in college. But in reality, your credit limit has no relation to what you can afford or how much you really should be spending. Credit card companies set your credit limit (how much they’re willing to loan you at one time) based on your record of paying bills and your other accounts. They really have no idea if you can pay off that much debt because it doesn’t know how much income you have right now or your net worth.
- The interest rate will stay the same over time – Fixed rate credit cards are not as common as they once were. Today, many credit card companies that once offered fixed rates have switched them to variable rates which go up when other interest rates go up. Some companies offer different interest rates depending on what you borrow the money for. For example, the interest rate for cash withdrawals are typically much higher than if you were transferring a balance from one credit card to another. Your interest rate will also go up is if you’re late on a payment or if your payment check bounces – sometimes as high as 30%.
- The interest rate is the only charge that I’ll see – Ha! Credit card companies don’t have those huge skyscrapers for nothing! They’ll charge you any chance you get. If you’re late on a payment or miss a payment, you could be charged a fee of $35. If you transfer a balance from one card to another, you could be charged a transfer fee of up to 5% of the balance. Want to get cash from your credit card? You’ll probably pay 5% or a minimum charge of $5 to $10. If you travel overseas or even to Mexico or Canada, you’ll pay a foreign transaction fee of up to $3.
Credit cards can be a really helpful financial tool if you pay off your balance each month. But if you fall for these myths, you can really dig yourself into a hole that is costly and hard to get out of.
Looking back on my college years when I got my first credit card, I think I’ve believed all of these credit card myths at one time or another. What about you? Which ones have you struggled with?
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