While credit cards certainly carry a degree of risk and can be deceptively complicated, they should not be written off in all instances. Particularly for young adults, closely-monitored credit cards are a financially savvy way to build credit.
While the risks are real, one of the main culprits against proper credit card responsibility is lack of understanding. Education and respect for the responsibility of using credit at will can bolster financial health by building and rebuilding credit, while haphazard use can lead down the rabbit hole of bottomless debt.
The benefits of owning a credit card or two are numerous. However, the risks associated with being a cardholder must be parsed out and the consequences of improper use recognized.
Purpose And Function Of Credit
One of the first and most important things to grasp when considering opening a line of credit is the function of credit. When the mindset of the cardholder is that of building credit as opposed to readily having “free money,” the likelihood of mishandling credit cards becomes minimalized.
Individuals need credit in order to make large purchases that generally cannot be made in cash feasibly. Responsible financial handling demonstrates to the lenders that they can give the individual a loan based on the track record of the borrower, and indicates that the borrower will pay the money back in an appropriate amount of time. Interest rates are placed on the loan in order to motivate the borrower to pay off the loan quickly.
Credit history is also necessary for long-term contracts, such as renting a home or an apartment. While the individual may pay a set fee at the first of the month for that month’s expenses, the contract is for an extended period of time. Therefore, a credit history is often pulled for the same reasons above – to show that over a long period of time, the individual has been financially responsible.
Additionally, credit histories can be pulled by future employers as an indicator of the prospective employee’s personality, character and disposition. In other words, having an extensive, healthy credit history is all but essential for adults.
When Credit Cards Are Not A Good Idea
Just as there are numerous reasons why having credit can be beneficial, there are a number of reasons credit should be avoided.
1. Individual Financial Weakness Or Financial Illiteracy
As Forbes contributor Luke Landes explained, “Credit cards are not for everyone. Like tools, in the wrong hands, they can be dangerous. If you have personality traits like a tendency to lack self-control, if you’re in the process of repairing your finances, or if you're not ready for personal responsibility, avoid credit cards until you are mentally and emotionally prepared.”
In addition to broad reasons why basic ownership may not be recommended, there are specific instances that can lead to irresponsible – and addictive – use.
2. Improper Use Of Credit: Spending On Unnecessary Expenses
Business Insider contributor Sarah Schmalbruch suggests that credit cards should be used in such a way that only specifically outlined purchases are made through the line(s) of credit, emphasizing that credit is not a mode for extravagance, but a way to proactively cushion future financial security. She illustrates this point by saying that an individual should hold “no more than two personal credit cards.”
“One of those cards should be reserved for regular, everyday use. The other should be used only in the case of an emergency. Medical bills, for example, count as an emergency. The new winter coat that you could use, but can't really afford is not an emergency.”
How To Build Credit
The bottom line is that credit cards are tools. In the right hands, with the right intentions, they can build and rebuild security. Used irrationally, improperly or without the correct education, they can be disastrous.
Simply owning the proper tool to build credit is not enough. Using the card at whim is not enough. Using the card and paying off tremendous debt and interest at a dastardly slow rate is not enough.
Using the line of credit regularly and paying off the credit frequently and in full is the only way to effectively build a solid, healthy credit history.
With proper self-control and complete comprehension about how credit actually works, individuals can use credit cards in such a way that helps and does not hinder their financial security.
This article was written in collaboration between NASDAQ contributor and Benzinga Managing Editor Joe Young and Benzinga Personal Financial Writer Rebecca Sheppard.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
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