A note of caution: The potential dangers of rewards credit cards

Rewards credit cards can be a double-edged sword. On the one side, they’re fantastic financial tools. As long as you wield them correctly, you can make safe transactions, and earn cash, points or miles to turn a profit. The other side, however, is decidedly dangerous. Misuse the cards and serious problems will erupt – and any rewards you’ve accumulated will be swallowed up by fees and interest. 

Know how bad things can get

It’s easy to focus on all the benefits that rewards credit cards provide, but switch gears and concentrate on the dangers they can pose. Here is what will or can happen if you use such an account without proper training or care. 

1. Payments will eat into your expenses. Every credit card has a credit line, which is the amount of money that you can borrow. But it’s that word “borrow” that people tend to forget until the bill arrives. The credit card issuer will send you a statement outlining all of your charges, with the total amount you owe and a minimum requested payment, which is the very least you can pay to keep the account in good standing. But even that small payment will be tough to part with when cash is tight. All credit payments, though, are going toward what you spent in the past, so you have less to work with in the present.

2. Persistent and expensive debt. If you charge more than you can repay quickly, you will soon be in over your head. The money you owe will be shifted over to the next month, and interest will be added. Interest compounds, so fees will be assessed on balances that have already grown with interest costs. How bad can it get? If you owe $5,000 to a card with a 25% APR and send only the bare minimum, it will take you 21 years to get out of debt and  — get ready — cost you $10,074.00 in interest charges. Yes. More than double what you spent on the purchases. 

3. Anxiety and depression. Credit card debt isn’t just about the numbers; it can damage your psychological well-being. Not only does this make logical sense (imagine always being behind, struggling to keep up with pressing bills), but research proving the connection abounds. For example, in a study about debt and mental health, Dr. John Gathergood of the University of Nottingham identified a strong correlation between carrying debt and severe anxiety and depression. That’s no way to live. 

4. Credit problems that lead to lost opportunities. From the moment you apply for a credit card, the credit card issuer will send your account activity to the credit reporting agencies. If you miss payments and your debt load is close to your credit limit, you’re in trouble. Credit scores are calculated on credit report information, and payment history and credit utilization are the two most important criteria. That will translate into present and future credit products that carry high interest rates, making borrowing money even more expensive. It will also make being eligible for credit cards with amazing rewards programs much harder. Oh, and anyone checking your credit reports will see what’s been going on and can make a negative judgment about you. That includes a landlord, who just may decide to reject you as a tenant.

5. Collection and legal action. If you do not pay your bills at all, the account will go into default. You will receive a barrage of demanding phone calls and letters attempting to collect. Eventually, the creditor will either sue you for the balance due or will sell it to a collection agency (and a collector can take you to court too). If you are sued, you might lose the case, resulting in a judgment on your credit report. The amount you owe will be even higher because court costs and associated fees will be tacked on. And if allowed, the judgment creditor may garnish your wages, so a portion of your paycheck will be deducted until the debt is repaid.

Know how to prevent problems

Thankfully of the nastiness above can be avoided by preparing your finances. Your first step is to have a steady income source so you can satisfy all of your bills, including sending a credit card payment. 

Your income sets the course for your budget. All of your expenses need to fit neatly within your total income. List and tally all of your bills, then subtract the total from your monthly pay. If you don’t come out at least even (extra for savings is ideal) you have a choice: earn more, reduce spending or both. 

Understanding and honoring your income and budget is critical to staying far away from the vast array of credit problems. If you’re short on funds, you may use the credit card to close the gap, and that’s where everything starts to go downhill.

Know the right – and rewarding – way to charge

When you have a credit card that offers rewards (and even one that doesn’t) remember the golden rule of plastic management: pay your bills on time and in full. Make it your mantra. Write it down on a post-it note and slap it on your card, phone and computer screen. It is your guaranteed way to stay far away from credit problems. 

Then you can begin to maximize the rewards that your credit card offers. Some are cash back, which will redeem a portion of your charges back to you, while others are points and miles cards. You’ll earn those rewards as you charge, and can redeem them for all kinds of things, from travel expenses to cash and gift cards. 

Identify the expenses in your budget that you can charge, and then use the card to rack up rewards. As long as you remember the golden rule, you’ll turn a profit. 

And now you know both sides of a credit card. These powerful products can either help or harm you, but the choice is yours. 

Erica Sandberg

San Francisco-based consumer finance journalist whose work appears in a wide variety of top-tier outlets.

Erica’s the resident money and credit authority for KRON-4 News and author of “Expecting Money: The Essential Financial Plan for New and Growing Families.” Erica is an amateur hockey player and ballet dancer and has the broken bones to prove it.