The pluses and perils of credit card ownership
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Getting a credit card is a rite of passage for most young adults.
Once 18 (or 19 depending on the jurisdiction), Canadians can sign up for a Visa, MasterCard or some other credit card to start their borrowing journey as consumers.
It can be a perilous trek.
The average credit card debt balances, according to December Equifax data, reached a record high of more than $2,100 in Canada — following 18 months in a row of increases after initially declining in the pandemic’s early days.
Interest rates — already steep — have inched up too recently from about 19.99 to 20.99 per cent or higher, Consumer Reports data show.
“We do get a lot of questions about them because young people have seen the horror stories of those who have fallen into debt,” says Jonathan Lee, a senior editor at creditcardGenius.ca, a comparison-shopping online marketplace for Canadian credit cards.
Yet getting a credit card is a financial journey most young consumers must take in our economic system largely built on borrowing money.
“There are also many upsides to credit cards with people who have done very well taking maximum advantage of what they offer,” he says.
Beyond ease of use — being widely accepted, more so than cash and debit — credit cards help individuals build a borrowing history and credit score to secure other, larger loans at better interest rates.
“It supports you in building good credit while you’re young and can help when renting an apartment, financing a car, and then ideally when applying for a mortgage,” says Natasha MacMillan, director of everyday banking at Ratehub.ca.
At the same time, most card providers — financial institutions and large retailers —have rewards programs to earn points or cash-back with purchases made.
Credit cards have other perks, including extended warranty coverage on purchases in some instances and limited insurance on car rentals and travel.
Yet the biggest advantage is building the credit history for future borrowing.
The challenge, of course, is using credit cards wisely to avoid running yourself ragged on the high-interest debt treadmill that can be hard to stop.
The key advice here is straightforward, but insidiously challenging to do consistently: “Only use your credit card when you can afford to pay off the balance at the end of the month,” MacMillian says.
Do this and you will be a golden consumer in lenders’ eyes while harvesting rewards points for free travel, gasoline, groceries, electronics… you name it.
What’s more, if you’re a post-secondary student, most financial institutions offer student cards with slightly lower interest rates, and no annual fees on cards with rewards programs, Lee says.
“The biggest thing is to think about what you’re trying to get out of a card.”
That is particularly the case with rewards. Start with a no-fee if possible. And if you are paying a fee, understand that your spending on the card must be substantial enough to accumulate enough rewards to cover the annual fee and more, Lee says.
“Some people overlook that (fee cost) for the shiny perks, thinking they’re getting a lot, but they can’t spend enough annually to earn the rewards to just cover the fee cost.”
Selecting a no-fee, rewards card best suited to an individual’s needs—like cash-back for groceries—is the best option for newbies.
Still, understand rewards programs are designed to encourage spending — for better and for worse.
“You have to remember not to let rewards points drive spending decisions,” says Ainsley Cunningham, manager of education and communications at the Manitoba Financial Services Agency.
The agency’s The Great Disconnect Podcast, which Cunningham hosts, has addressed borrowing for young people in recent months which includes credit cards.
She points to behavioural finance research showing credit cards are difficult to manage psychologically because our brains don’t value it the same as cash.
“When we pull cash out of our wallet, it feels more difficult to spend,” she says. “Credit cards make the purchase feel less painful, and therefore, we’re more apt to use them.”
More recent research also shows, by the way, the same principle applies to spending using a mobile phone backed by a credit card.
As well, studies show rewards programs also boost spending.
If you’re thinking financial companies do this on purpose, you’re probably not wrong.
U.S. data show most credit card issuer profits are driven by “revolvers” with ongoing balances, making up 60 per cent of accounts and as much as 90 per cent revenues.
Governments understand the perils, which is why the Financial Consumer Agency of Canada’s (FCAC) has extensive, objective advice on how to use them wisely.
Among its recommendations is discerning good debt (student loan) from bad (a round of beer on the Visa), says Jeremie Ryan, director of consumer services and information at the FCAC.
“Set goals to purchase with savings instead of credit,” Ryan says, adding that can purchase can still involve using a credit card, but the money must be there to pay it off the debt.
If you do overspend — easy to do as a cash-strapped young adult — make more than the minimum payment. Although paying the minimum is still positive for credit history, you will have a hard time getting off the debt treadmill and could pay as much in interest as the original purchase price by the time the debt is paid in full, Lee says.
“There is always temptation to buy with money we don’t have,” he says, pointing to friends who have felt the crush of credit card debt.
“They learned the hard way.”