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Credit cards - good news and bad news

Credit cards are a convenience which allow you to spend without carrying cash around. They can help you establish a good credit rating to get a home mortgage or other loans. They enable you to make installment repayments over time. Credit cards function like a line of credit, allowing you to spend up to a certain fixed dollar limit. The credit card company determines your credit limit by your credit rating.

The ease of using "plastic" can lead to financial disaster. According to recent figures, the average credit card debt in this country is now about $8,900, but can be much higher, depending on age and location. Individuals carry an average of 2-3 credit cards. The Federal Reserve Board estimates that consumers now devote one third of their income to paying credit card debt.

Finding the best credit cards

Credit card applications find their way into your mailbox on a regular basis. But not all credit cards are the same. Terms and conditions vary widely.

• Fees. Many cards have no annual fees. Others charge $20 and up. For example, the American Express Gold Card carries a $75 annual fee and the American Express Platinum Card has a $300 annual fee. For most people, the perks or extra benefits don't justify the cost. People who travel frequently on business may take advantage of these benefits, but others won't gain anything other than the prestige of a gold or platinum card.

Strategy: Look for a no-fee card offered as part of a package deal. Banks, for example, may offer a senior banking package that includes a no-fee credit card. Brokerage firms may give credit cards to investors with "wrap accounts," but with an annual fee.

• Interest rate. Rates can range up to 21% or more annually. An annual rate of 18% means interest is accruing at 1% per month! Some cards offer a very low introductory rate to entice you to transfer account balances from higher-interest cards. Caution: There may be dollar limits on what you can transfer. And you may be charged for interest on the transfer from the very first day. While the low rates offered by some credit card companies may be appealing, you may need to look for another low-rate card at the end of the introductory period-typically six months-or wind up paying a high rate after that.

• Billing cycle. Most credit cards are on a 25-day billing cycle. This cycle operates as a grace period. If you pay your outstanding balance within the cycle, you don't incur any interest charges. Caution: Credit card companies aren't required to offer this grace period. Avoid credit card offers that don't mention a grace period.

• Other charges. Read the fine print of your credit card agreement to learn about other fees and penalties you may owe. For example, some cards charge a fee for cash advances.

Strategy: Don't carry more credit cards than you really need. Usually a single card from each type of major issuer-MasterCard, American Express, etc.-is sufficient. This will keep temptation down by minimizing your credit limit.

Types of credit cards: There are several kinds of credit cards:

• Bank cards (MasterCard, Visa, Discover)

• General credit cards (American Express, Carte Blanche, Diners Club)

• Proprietary cards issued by companies for use only at their stores or facilities (Sears, Staples, Saks, Texaco)

Strategy: Use credit union credit cards available to members of a credit union and their families. They typically carry a lower rate of interest than commercial credit cards.

Repayment

Making only the minimum payment each month can keep you in debt for more than 11 years! You must pay more than the minimum to reduce the outstanding balance and get out of debt.

Pay off old debt before incurring new debt. This isn't always easy to do-emergencies do arise. But postpone discretionary purchases until you pay off the existing balance on your credit cards or at least bring it down substantially.

Strategy: Mail your credit card payment at least one week prior to the due date. If your payment is just one day late, it can trigger a penalty of $25 or more.

Debit cards

Debit cards are made out of the same plastic as credit cards, but they're different in many ways. Debit cards function like credit cards by letting you purchase goods and services without cash on hand. But debit cards are tied to your bank account, and the amount you can charge is limited to what's in your account.

Advantages:

• You can't spend more than you have. You can't get into debt by using your debit card, unless your account has a line of credit that you tap into.

• You can easily obtain a debit card even if your credit rating prevents or limits your using a credit card.

• Debit cards are a convenient alternative to checks. You don't need to carry checks. You can access your funds when you travel, eliminating the need to carry travelers' checks.

Disadvantages:

• There's no grace period for payment. The funds are immediately subtracted from your account.

• They do not have the same transaction protection as credit cards. For example, if goods purchased with a debit card aren't delivered, you still must pay for them. In contrast, you can contest such charges on a credit card.

• If someone gains access to your card, he or she can deplete your bank account.

Smart cards

A variation on the debit card is the smart card, or store-value card. This isn't tied to your bank account; instead, it's purchased for a fixed amount and used only for a limited purpose. The amount you pay for the card determines what can be charged to the card. Examples: Phone cards and college campus cards.