Making or Breaking Your Credit Card Deals

August 02, 2007

When you take out a credit card, both you and the credit card provider are taking a risk. All credit card deals involve an inherent amount of risk, both to you and to them. Life is full of risks, some that we take and some that we don't. There are stupid risks, calculated risks and risks that promise great rewards. Sometimes we are willing to take a great risk that promises a great reward, but most people are reasonably conservative in their thinking and prefer reducing the risk as much as possible. With credit cards, there is one way to both reduce the risk and increase the reward and that is arming you with information. Understand how credit cards work and know exactly what you are getting yourself into when you sign up for a credit card.

Researching beforehand and having an arsenal of knowledge at your disposal will allow you to find all the best credit card deals as well as allowing you to maintain your good credit or alternatively fix your bad credit.

The History of Credit Cards

The advent of the credit card was in the 1950s and at the time it represented a radical new twist on money lending. Before credit cards the only method in existence for money lending was the traditional loan. This was a loan given to a person that put up collateral.

The lender was safe in this lending scheme as if the borrower could not pay back the loan, then the lender simply confiscated the collateral. There was no talk of having a poor credit history or working out good credit card deals. Things were simpler; you both paid the loan and kept your collateral or you couldn't pay the loan and lost it.

Traditional loans are still widely in use today, with good examples of them being a mortgage arrangement or car financing. Both of these are loans based on collateral and do not represent as high a risk to the lender as credit card deals do.

The Credit Card Issue Takes Risks

The first thing to understand is that both sides of the credit extending relationship take risks.

With the lender, the risk is the lack of collateral. All good credit card deals involve a blatant lack of collateral, so if the borrower is not able to pay the money back, the lender has absolutely no course of action to take. With a traditional loan, the lender would simply take the collateral, but with a credit card it is nowhere near as simple as that.

Lenders know the risk they are taking and they offset it in two ways. First and foremost, they charge interest rates under the philosophy that since they are taking a risk, they should get a reward. Think of yourself as a stock and them as an investor. They are putting their money into you on a gamble with the knowledge that if the gamble pays off, they will get rewarded handsomely.

The second way they offset it is to study the credit history of people trying to sign up with them. While they may still extend credit to people that have a poor credit history, you can be very sure that the interest rate will be much higher than that of a person with an excellent credit history.

Falling back on our investor metaphor, this is a higher risk, higher reward investment for them. They are less sure of being able to get their money back, so they are going to make sure that they get more of it back if they do, thereby making the overall payoff better.

You Are Also Taking a Risk When You Get a Credit Card

While the lender risks as well as the reason for interest rates are reasonably conceptual in nature, something people don't consider when applying for a credit card is the risk that they're taking. Remember that both the lender and the borrower take risks and as a borrower, failing to consider your own risk can end up being catastrophic.

The risk here is that with a large credit limit and a high interest rate, it can be very easy for an undisciplined person to find themselves in a deep financial hole that can take time to dig out of (if they ever get out at all). Remember that even the best credit card deals usually come with interest rates and that good credit card deals can turn sour really quickly if handled with a lack of discipline.

Having a credit card is great, but if you let yourself go and spend until you're in over your head and full of debt, your good credit can turn bad very quickly and repairing it will take a much longer time than ruining it did.

If You Are Already in Credit Card Debt

If you've already dug yourself into a whole, there are ways to get out of it.

First and foremost, stop spending! At least for the moment. You need to get your debt under control and start making regular payments that are at least the minimum. Once you've done that, then it's time to start rebuilding your credit rating. Ironically, the best way to do that is utilize that which got you into trouble in the first place, namely your credit cards.

Start using them again and make sure to a) not go overboard, only make small purchases with them and b) pay those purchases off in full. If you establish a pattern of this over a period of a few months, people will start to notice and your bad credit will start to improve. More recent information is more important than older information, so if you are diligent about showing your good handling of credit, you can end up restoring your excellent credit history.

Credit cards are fun, easy to use and very convenient. They're also safer to carry around than cash and this more than anything else makes them better to have. But you need to be disciplined about your credit card use. Don't overextend yourself and be diligent about paying your bills on time. If you do this, credit cards will make your life easier. If you don't, they could easily imprison you in a financial cell that is not by any means easy to get out of.

And always keep in mind that both you and your credit card company are always taking a risk on each other.