Monday, December 11, 2006
How I Gave Myself a Learner's Permit for My Credit Cards
I've never paid a finance charge on a credit card. With the exception of hiring a moving truck two and a half years ago, I've never exceeded 50 percent of my credit limit. I've never been in the position of wondering how I would pay my card off.

I'm not trying to brag. I've just noticed that there are plenty of advocates for never using a credit card and then there are those who snatch up every balance transfer opportunity in sight. And it seems to me that part of the issue is that getting a credit card is a bright-line, instant change that doesn't come with much (or any) training.

Compare that to learning to drive. Driving offers convenience and independence, much like credit cards. And it also involves a lot of risks, even MORE so than credit cards. Because of this, most states require that young drivers complete graduated licensing programs, which insure that they are supervised for months while learning how a large, heavy vehicle works.

So I set up my own "graduated credit" program. I really went full scale AFTER I graduated from college, but this is easily applicable to college students.

Step 1: Use a bank or credit union debit card for every possible transaction for one year, but remain an authorized user on another credit account. Groceries, drugstore items, bus tokens, etc. Any point-of-sale transaction should be paid for via debit. Some people are advocates of doing all spending with cash. That's admirable, but the point is to teach yourself how to keep track of your funds while using a little plastic card. I recommend that you choose a bank that lets you keep track of all your transactions online (although I'm hard pressed to think of one that DOESN'T, nowadays.) You may consider a budget tracking program for this as well.

The only exceptions are 1) cash for restaurants and bars. You'll probably be going out with other people and putting in cash is easier. And you don't have to worry about your card being skimmed. Just remember that you made these purchases. 2) Major consumer purchases and all online purchases. Despite my fondness for debit cards, they do NOT offer the same protection as credit cards, and anyone who tells you otherwise is confused or deliberately misleading. You'll need extra help while you stick to your debit-only plan. In my case, I was an authorized user on my father's credit card, and was able to use it to reserve plane tickets for trips home. (I'd then try to pay him back as he waved me off, but that's another issue.) I didn't buy any other big-ticket items that year, but if I had, I would also have wanted the consumer dispute protection of a credit card.

If you cannot find someone to authorize you on a card, get a second bank account with another debit card. Transfer funds to this account for your online purchases. Should your card information be compromised, you don't have to worry about your main checking account being hacked. You should also put all money for plane ticket and other large purchases here for the same reason. Alternatively, you may be able to convince your family to make reservations on your behalf and to pay them back later.

Step 2: Evaluate after six months.

Have you ever lost track of your spending? Did you have to dip into savings for anything other than real emergencies? Have you been hit with any overdraft charges? If the answer to any of these is "yes," you probably need to refine your budgeting and tracking skills. If you haven't used a budgeting program, or you don't like the one that you currently have, consider trying a new one. Follow step 1 again for another six months. And remember, whatever problems you have dealing with debit cards will only be exacerbated when dealing with credit cards.

Step 3: After six successful months with a debit card, get a relatively low-limit credit card from your bank or credit union.

Why would I recommend a bank credit card when the rates will probably be higher than other offers you might find? 1) If you already have a financial relationship with your bank, they'll be more willing to issue you a card. They know where your funds are. 2) You'll probably be able to keep track of your card balance on the same web page as your other accounts with the bank. If you can't, look around until you find a financial institution that has that setup. You want to see your credit transactions every time you log in, so that your spending can't get away from you.

I recommend that you avoid a huge credit limit off the bat. On the other hand, the lower the limit, the worse your utilization ratio will be for purchasing anything more than sticks of gum. I had roughly a $1500 credit limit when I first applied, which was less than 4 percent of my annual income at the time. Under $2000 is likely to keep you from getting into too much trouble if you start running up charges.

Continue to use your debit card for the majority of your purchases. Keep the credit card for small recurring purchases (a newspaper subscription or somesuch) and the aforementioned plane tickets and online purchases. If you find yourself spending more on your credit card than you did with your debit card, take a break, evaluate your budget, and rein in your spending.

Step 4: Again, evaluate after six months.

Were you able to pay off your bill in full every month? Did you usually stay below 30 percent of your credit limit? Do you trust yourself when you take out this card?

If the answer to these is "no," then put the card aside for awhile, and go back to the debit. Do not close the card, but lock it away and pay down your remaining debt. You can try using the card again AFTER you pay down your credit balance in full. Evaluate again after another six months. Continue using your debit and SINGLE credit card for a year.

Step 5: After a year of responsible credit card usage, look into rewards cards or zero percent cards.

These offers provide even more convenience than normal credit cards, which is why they are risky. However, if you know that you can pay your balance off in full by the time the statement is due (or the promotion period, in the case of zero percent cards), then you can take advantage of these with confidence. Remember that opening a lot of new cards can ping your credit score, however. I think waiting a year or two and then searching for better offers is fine, as long as you can continue to keep track of your old cards.

So, that's how I graduated from debit-only to regular use of cards without getting in over my head. I don't claim that this will work for EVERYONE, but I suspect it might help some young people who feel overwhelmed.

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Anonymous Debt Hater said...

That's a great primer to credit card use! Might have saved me a lot of headache in the past if I had the same advice. Unlike you, I've paid thousands in finance charges... it's so painful.

Blogger HC said...

DH, I'm glad you found it useful!

And trust me, with my student loans, I WELL know the pain of finance charges. Nothing better than sending in $245 and seeing your principal balance drop by a whole...$26.

Blogger mybadcredit said...

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Blogger Jurex said...

Thanks for sharing these tips. Keep posting helpful tips.

Btw, for those who has bad credit score, don't worry. It is not the end of the world :D. There are many lenders now that specialized in providing bad credit loans and bad debt credit cards.

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