Take iPads, for example. iPads are an incredible tool that can be used for so much good: you can read books, watch educational videos from The Money Guy Show, create art, write articles, get in shape using fitness training apps or videos, and so much more. Just as much as iPads can be used to improve your life, though, they can be harmful. Maybe you use your tablet to watch 8 hours of mind-numbing television per day or have developed a sports gambling habit on one of many betting apps available on tablets. 

Credit cards, just like any other tool, can be helpful or harmful depending on how you use it. Here’s how to use credit cards the right way, so they can be a valuable tool in your financial life, and what to avoid doing with credit cards.

Pros of using credit cards

Credit cards are usually the most convenient way to pay for a transaction. It is quick; all it takes is a simple tap or insert of your credit card chip into a card reader and the transaction is done. Long gone are the days of counting out the change in your coin purse or writing a paper check. One of the greatest “conveniences” of credit cards, and the biggest dangers, is that you don’t even need to have the money in your bank account to complete the transaction.

It costs merchants more to accept credit cards due to processing fees, and while some business owners charge credit card users more, the majority charge the same prices to both credit card users and those that pay in cash or cash-equivalents. This means that if you use cash or equivalents (like a debit card with no rewards) you are subsidizing credit card fees. The Federal Reserve has estimated that each household in the United States that uses credit cards receives an annual wealth transfer of $1,133 from cash users.

The benefits of credit cards go well beyond convenience and having cash users subsidize the prices you pay. Here are some other common benefits credit cards offer.

1. Fraud protection

Shop with a credit card anywhere you’d like a little extra protection. By law, your liability is limited to a maximum of $50 for unauthorized transactions, but most card issuers have zero fraud liability policies.

2. Points or rewards

Some credit cards offer cash back rewards that can be redeemed as statement credits or other cash equivalents. Others offer rewards that may only be redeemed for certain things, like miles for traveling or points for gift cards.

3. Extended warranties

Potentially one of the greatest features of a credit card is extended warranties. If you are making a big purchase, like an expensive home appliance or television, using a credit card with an extended warranty feature. This could help replace the purchase later down the road if something goes wrong.

4. Price matching

Some credit cards will price match items, which means if you make a purchase with your credit card and the price later drops, you can get a credit for the difference.

5. Insurance

Credit cards may offer travel or trip insurance that covers you if your flight is delayed or you use your luggage. Using a card with this feature can be great for frequent travelers.

Credit card pitfalls to avoid

Why would anyone not use credit cards? It’s the most convenient way to pay, you are essentially paying less for every purchase if you are receiving credit card rewards, and your card issuer may also offer benefits like price matching, extended warranties, and insurance. All of those benefits come at a price, though, and credit card companies aren’t operating out of the goodness of their heart.

The biggest pitfall is overspending. Studies show that people spend about 12% to 18% more, on average, when using credit cards. Credit card spending often doesn’t feel as “real” as seeing money come out of your bank account or handing over cash. Even if you pay your credit cards in full every month, you still might be spending more than you would if you weren’t using them at all. Credit card rewards and other benefits can make up some of the difference, but not all. If most Americans spend 12% to 18% more when using credit cards, it’s safe to say that most Americans would be better off not using credit cards.

Unless you have the excess income to cover credit card overspending, it will naturally lead to credit card debt. That sounds scary just to type; almost like a dentist warning you that not brushing will lead to cavities, tooth decay, and eventually, root canals. Credit card debt might even be less pleasant than having work done at the dentist.

Credit card debt is extremely harmful because it weaponizes compounding interest. Not only does it use compounding interest to harm you, the average interest rate on credit cards, at 24.20%, is substantially higher than you can expect to earn by investing in the stock market. Unfortunately, almost half of all credit card users carry a balance from month to month.

Credit cards can be financially beneficial when used properly, but they can be extremely damaging to your financial life if you carry a balance. If you have trouble controlling your spending when using credit cards, there is nothing wrong with foregoing the benefits of credit cards and using only debit cards. If you are an overspender and will carry a credit card balance, the benefits of using credit cards pale in comparison to the harm that carrying credit card debt can cause.

Despite how harmful credit card debt can be, it is very common. Almost half of all credit card users are in debt, and the average American household with credit card balances owes $6,270 in debt. If they are paying the average interest rate of 24.20%, that means they would be paying $1,517 per year in interest.

If you find yourself carrying credit card debt, you are not alone. Unfortunately, shame and embarrassment can hinder your ability to focus on the debt and pay it off as quickly as possible. Here’s how to get rid of credit card debt for good and relieve yourself of the stress and anxiety that always comes with high-interest debt.

1. Know how much debt you have

You may know exactly how much credit card debt you carry down to the penny, in which case figuring out how much debt you have seems like a silly suggestion. However, many Americans avoid thinking about their debt at all costs, and around 25% don’t know how much credit card debt they have. If you are part of this 25%, the first (very painful) step to getting out of debt is determining exactly how much debt you have and the interest rate on each credit card, if you carry debt on more than one card. Knowing how big the problem is makes it more difficult to ignore and helps you prioritize which credit card to pay off first.

2. Determine how much you spend each month

The next step to paying off your credit card debt is determining how much you spend each month. If you have credit card debt, chances are you may be spending more than you make (unless your debt is due to one-off spending for emergencies). Take a moment to sit down, look at all of your accounts, and categorize all of your expenses from the prior month. If you are spending more than you make, your budget is not sustainable and you will continue to accumulate more credit card debt unless you make a change. You must reduce your spending or increase your income to pay off your debt. 

3. Develop a plan for paying off your debt (and stop using the card)

Once you know how much you are spending every month and have (or can make) room in your budget, next you will develop a plan for paying off your credit card debt. Make your debt a priority and a top-level budget item instead of just using whatever money is leftover at the end of the month on your debt. Dedicate as much money as possible to your credit card debt; it is in your best interest to get rid of it as quickly as possible. Financially, it is better to prioritize debts in order of interest rate and pay off the highest interest rate debts first. Some believe in paying off the smallest debts first, which may give you the motivation you need to keep going. Check out our take on the avalanche vs. snowball method if you are curious which may be right for you.

An important step of getting rid of credit card debt is making sure you don’t accumulate any additional credit card debt while you are working to pay yours off. It may make sense to only use a debit card if you are prone to overspending when using credit cards.

4. Implement your plan (and make changes as necessary)

Now that you know how much debt you have, know what you are spending each month, and have developed a plan for getting out of debt, it should be smooth sailing, right? Maybe! But maybe not. Prepare for setbacks and have a plan for when things don’t go quite as expected. What if you have an emergency vet bill of $2,000 one month? Or worse, what if you or your spouse lost their job? Everything might not go as expected when paying off your credit card debt. Your “get out of debt” plan should evolve if your financial situation changes.

If you experience unexpected expenses one month that hinder your ability to pay off debt, look for ways to make more room in your budget. Maybe it makes sense to spend a month not eating out and shopping at a discount grocer like Aldi. Hopefully your plan will go as expected or better than expected, but a willingness to make changes to your plan and make sacrifices might be necessary to ensure your success.

Nobody wants to have credit card debt, and rarely does anyone plan to take years and years to pay off their cards. Credit card debt usually starts small. It’s easy to make a purchase on your card without the money to pay for it. After all, you can just pay off your credit card when you get paid and you won’t even owe any interest. What’s the harm in that? But maybe you have a minor financial emergency right after you get paid. You have to use your paycheck to take care of the emergency, but that’s alright. You can pay off your credit card next month.

Next month comes around faster than you expected and after last month’s financial emergency, you aren’t sure you have enough money for groceries and gas this month, much less extra money to pay off your credit card. The stress from worrying about money could lead you to make more poor financial decisions. Spending money on your credit card helps you forget that you don’t actually have the money to be spending on your credit card, if only for a moment. Next month your credit card balance and stress both grow and the cycle continues.

It is all too easy to fall into credit card debt. Remember that you are not alone and this is a trap that ensnares millions of Americans. It may not feel like it right now, but it is possible to get rid of your credit card debt completely and never look back.

History of credit card interest rates

Credit card debt is unsecured debt, which means you are not required to “secure” the debt with an asset. Mortgages and car loans are two common types of secured debt, or debt backed by collateral. If you fail to pay your mortgage or car loan, the bank has collateral (your house or car) it can repossess. Interest rates on mortgages and cars are naturally lower than credit card interest rates because the debt is secured.

Comparing credit card interest rates to mortgage and car loan rates isn’t a fair comparison, but we can compare credit card interest rates today to historical rates. Credit card APRs are currently at an all-time high since the Federal Reserve began tracking data back in 1994, but the federal funds effective rate has also risen significantly over the past few years. Instead of comparing credit card rates now to credit card rates a few years ago, I want to compare credit card rates now to a time when overall interest rates were similar.

The Federal Funds effective rate is currently 5.33%. From October of 1994 through December of 2000, the average federal funds rate was 5.51%. All else being equal, I would expect credit card rates to be about the same in that period as they are today – if not a little higher back then since federal rates were higher. But that is not what we’re seeing. From the 4th quarter of 1994, when the Federal Reserve began tracking credit card APRs, to the end of 2000, the average credit card interest rate on accounts being charged interest was 15.39%. Today, the average credit card interest rate on accounts being charged interest is 22.75%. This chart from the Consumer Financial Protection Bureau shows how credit card rates have risen much faster than prime rate.

Why is there such a large discrepancy? Is it more expensive to lend now or is something else going on?

Why credit card interest rates have gone up

To give credit card companies the benefit of the doubt, if more Americans are not paying off their debts, raising credit card interest rates would be a natural way to maintain your profit margin and protect your company from losses. Fortunately all of this data is tracked so we can see if this is why credit card rates are so much higher these days. This chart, also from the Consumer Financial Protection Bureau, shows the APR margin of credit card companies and the charge-off rate. The charge-off rate is the percentage of defaulted balances compared to the total amount of credit outstanding.

This chart is insane to me. 1995 to 2011 are what I would expect the chart to look like, and then we see a huge divergence after 2011. The APR margin for credit card companies keeps rising while the charge-off rate remains low and steady. What does this mean? Credit card companies are making more money than ever off of Americans. But there is a way you can win and beat the credit card companies at their own game.

How to beat the credit card companies

Credit card companies will likely continue increasing their profit margins over time, which means consumers with credit card debt will pay more and more interest to credit card companies. However, you can beat the credit card companies at their own game. We believe it is possible to responsibly use credit cards and not carry a balance from month-to-month. If you are able to do this, you will receive all of the benefits of using credit cards (rewards, better protection, extended warranties, travel benefits, and more) with none of the penalties (high interest rates and fees).

Not all Americans are able to use credit cards responsibly. The data shows that only 35% of cardholders always pay their balance in full every month. If you are part of the majority of Americans that does not use credit cards responsibly, credit cards might not be for you – and that’s okay. It is much better to use debit cards and have a little less protection and fewer rewards than to rack up debt on a credit card and pay an exorbitant amount in interest and fees to credit card companies.

The interest rate on credit cards has changed significantly since the 1990s, but the trap you need to avoid has not changed. Don’t let credit card companies win and make money off of your hard-earned dollars. Put that money to work for you and start investing today. Check out our new Wealth Multiplier tool to see exactly what each dollar you save in credit card interest could turn into by retirement.

Are credit scores a scam? Debt can be chainsaw dangerous, but it is possible to maintain a great credit score while having a healthy relationship with debt.

Want to know what to do with your next dollar? You need this free download: the Financial Order of Operations. It’s our nine tried-and-true steps that will help you secure your financial future.

Using credit cards responsibly can help build your credit score, earn you cash back, and get you other rewards options. Unfortunately, the majority of people aren’t paying their credit cards off every month, and it costs them hundreds, sometimes thousands, of dollars per year. Just like compounding interest will grow your army of dollar bills over time, compounding debt will destroy it. The average American owes over $7,000 in credit card debt. You can imagine how that debt will slowly become harder to overcome.

We want you as a Financial Mutant to avoid the trap of credit card debt entirely. Our rule of thumb: If you use a credit card, you HAVE to pay them off every month. If you have trouble using credit cards responsibly, it is best to avoid them entirely.

For more on the ins and outs of credit cards, pros of using them, and pitfalls to avoid, check out this article: “Why Credit Cards Can Be a Dangerous Weapon (or a Powerful Tool).”

In this highlight, we discuss if you should use a 0% APR credit card as an interest-free loan.