The Holiday Borrowing Risk List
Ch. 3.1. Credit Cards
Most Americans have at least one credit card in their wallet, so using one to fund holiday spending might seem like the easiest option. But you need to be careful with credit card spending: interest can build up quickly. There’s a reason why, as of May 2016, Americans had built up $953.3 billion in outstanding revolving debt – the vast majority of that debt comes from credit cards. While interest rates can vary depending on your credit score, the average rate is currently at 15.97 percent, not exactly a small amount.9
If you decide to use a credit card for holiday shopping, remember that not all cards are created equal.
For example, some general use credit cards (the kind you can use anywhere) have an interest-free grace period on purchases, meaning they won’t charge you interest so long as you pay off your statement balance in full every month. This is good for the responsible shopper who always takes care never to carry a balance on their credit cards, but not everyone is capable of paying off their bill in full every month, especially during the big-spending months leading up to the holidays.
Cards with interest-free grace periods are different than cards that offer deferred or no interest introductory periods, which are often widely promoted during the holiday season.
Deferred-interest cards won’t charge any interest on your balance during the promotional period – usually six months to a year. The catch is that, in order to pay no interest on any purchases you make during that time, you’ll need to pay off your entire balance before the promotional period is up. If it ends and you’re still carrying a large balance, all of the interest you racked up during that time will be applied in full. According to the Consumer Financial Protection Bureau (CFPB), interest on these kinds of cards is typically calculated based on the balance you owe each month. If your promotional period is a year and you don’t pay it off in that time, or if you are more than 60 days late in making a minimum payment, “you will be charged interest for each month on the balance you owed in each of the 12 months,” which kind of defeats the purpose of getting a card like this in the first place. Unless you’re sure you’ll be able to pay off your balance in full by the end of the promotional period, you should stay away from cards like this for holiday shopping.
No-interest credit cards, by contrast, offer an introductory period that is truly interest-free. No interest is charged, nor does it accumulate during the promotional period, so long as you’re making your minimum payments on time every month. However, if you make a late payment, your introductory period will be abruptly canceled, and when the promotional period is up, some of these cards may start charging interest as high as 25 percent.10 These kinds of promotions are definitely better than deferred-interest promotions, but if you use one for holiday shopping, you need to be careful that you’re making your payments on time, and you should try as hard as you can to pay off your card in full before the interest-free period is over.
During the holidays, you’ll notice an influx of marketing for store credit cards, some of which are closed-loop credit cards that can only be used at one specific retailer, and some of which are general-use cards that can be used anywhere that accepts credit. The holiday season is typically rife with deals surrounding these kinds of credit cards. Some stores will take a set percentage off any purchase made with their card, some will offer no interest until the new year, and some will throw in freebies like cash back or even free merchandise for signing up. But you should be very careful with store credit cards: even applying for one can negatively affect your credit score, and many only have one interest rate option, not a variable rate that’s lower for people with better credit.11
The other major downside to retailer credit cards? When you use a store credit card, your lender is actually a bank, not the store, which means falling behind on your payments can have a very real and very negative impact on your long-term finances.
Bruce McClary, Vice President of Public Relations and Communications for the National Foundation for Credit Counseling, said he has a relative whose excellent credit score was damaged by one of these cards.
“I think people should be careful when considering in-store financing or credit cards that come with introductory discounted interest rates,” McClary said. “These are very attractive to a lot of shoppers during holiday season… the caution flag is associated with how people approach repaying the balance once it’s time to move past the holidays and start clearing that debt.”
McClary says that if you do take advantage of an in-store offer, it pays to remember that the person at the register isn’t a financial advisor and won’t know whether or not that offer is actually a good one. If the promotional rate expires in a year, make a plan to pay it off in six months. If the promo is six months, pay it off in three, and so on.
If you want to use a credit card as a way to build credit, look for one that has cash-back deals and can earn you money or points on purchases you make. Some cards even partner with different retailers in order to offer higher cash-back percentages during the holidays, or sweet travel deals that can cut the cost of getting home for the holidays down to zero.12