The topic of whether to hold on to credit cards or replace them with cash and a debit card instead has become a major issue since the onset of the current recession. With so many people losing out on a mortgage loan or some other form of credit because of failures in the banking industry and on Wall Street, some have decided to do away with credit completely and work with cash to better manage their money and spending habits.
Unfortunately, we still live in a credit-based society which requires consumers to have a good credit score to qualify for things like home loans, car financing, various forms of insurance and even a job. Recently, Ray Martin, a financial contributor for CBS’ MoneyWatch.com, recommended that consumers hold onto their credit even if they don’t think they should. This opinion forces a new question regarding money management: Should we or should we not use credit?
Ray Martin’s Thoughts on Credit
In February, Ray Martin shared his thoughts on people ditching their credit cards and instead opting for cash or debit cards after the financial crisis. In 2009, credit card usage saw a 50 percent decline, largely due to people feeling financially scarred by the effects the crisis had on their mortgages and credit cards.
However, Martin expressed his belief that despite consumers’ fear that relying on credit could result in long-term debt if not managed correctly, they should still keep at least one credit card in their possession.
The Credit Card’s Effect on Individual Credit
One reason Martin suggested holding onto credit cards is the major influence they have on a person’s credit. While there is no definitive explanation available to show exactly how credit cards factor into credit scoring, experts have determined what they believe to be the basic formula for calculating credit:
- Payment history – 35 percent
- Types of credit used – 30 percent
- Amount owed – 15 percent
- Length of credit history – 10 percent
- New credit – 10 percent
From the breakdown above, you see that credit cards could factor into every percentage and therefore, could have a hugely negative or positive impact on your score and credit card rates, depending on usage.
Further, the average consumer with a credit card has a higher score (689) than a person without a card (563), according to Martin’s article and CreditKarma.com data. These facts point to definite benefits of maintaining a credit card in good standing.
Benefits of Avoiding Credit
While credit is undoubtedly important in today’s society, there are still some benefits to avoiding credit:
- Saving money: When you pay for items with straight cash, you don’t have to worry about the inflated cost of the same item after interest has accumulated on your card.
- No financial surprises: When you own credit cards, you may be surprised by hidden fees, increased interest rates and lowered credit limits. In other words, your money can be manipulated without your knowing. If you use cash, however, surprises are less likely to occur.
For an example of the benefits of using cash only, take a look at the following scenario:
Suppose there is a television that you want to purchase for $1,000, after tax, but you only have $500 available from this and next month’s paychecks to dedicate to the purchase. How would you pay for it, with cash or credit?
If you buy the TV now with a credit card, then pay-off the balance in two months at a 17-percent monthly APR, you will have added $14.16 per month to the principle cost and paid a total of $1,028.33 for it. If you instead save money for two months, being charged no interest, you simply pay $1,000 when it’s time to buy.
Clearly, the cash system saves you money. However, with the benefits of having a credit card also apparent, which is right for you?
Obtaining One Credit Card Won’t Hurt You
So here is the question that has not yet been answered: should I establish (or improve) credit instead of sticking to cash?
The answer is yes.
The key, however, is moderation. While according to Martin, the average consumer has five credit cards, you don’t have to have that many in order to build and manage your credit .
Many financial experts recommend having one or two credit cards that are used at least once a month and paid-off on time. This way, you could largely spend only with cash and debit cards while using your credit cards periodically for the single purpose of building your credit.
You could even start by obtaining just one card while paying-off any other outstanding debt you have. This could help you qualify for previously mentioned loans with better rates. Eventually, it would be good to have a couple of credit cards with high limits, one new car loan or mortgage loan and maybe a few retail cards in good standing. If you are able to maintain a good credit utilization ratio as well, you should have a great score in no time.
What if My Credit is Too Bad to Get a Card?
While poor credit can prevent you from obtaining credit cards with the lowest interest rates, you can always obtain a decent card no matter what your credit standing is. In fact, there are credit cards for bad credit that help people like you get back on track.
Some credit cards for bad credit may require that you deposit cash in advance (a secured card) and come with high interest rates, but they work just as well in building your credit and helping to increase your score enough to qualify for a traditional credit card.
After so many found themselves caught in the trap of spending money they didn’t have and being charged high interest rates and fees, it’s no wonder that people want to ditch their credit and work with a cash-only system. Unfortunately, our economy doesn’t function this way. Credit isn’t going anywhere and will always be used as a judgment of our financial soundness.