Understanding the Downsides of Credit Card Use: Financial Risks & How to Avoid Them

While credit cards can be convenient and in some circumstances, provide cardholders with cash and other rewards simply for using them, there is a downside to spending on credit. There are a number of negative side effects associated with credit card use that can have a serious impact on your financial future.

Credit Score

While using your credit card wisely can help you to build your credit score, misusing your credit cards can actually hurt your credit. Part of your FICO credit score is based on how many accounts you have open and the ratio of balances to overall credit limits. If you have multiple credit cards with balances that are close to or at the limit, this will be reflected negatively in your credit score. This, in turn, can end up costing you more money in terms of the interest rates you can get for other types of credit, such as a mortgage or car loan.

Overspending

When you spend with cash, you are able to physically see exactly how much your spending. When you spend with credit, it's easy to overspend because no money actually changes hands, and you don't really feel the effects of spending. It's tempting to spend more freely with a credit card since you're not actually sacrificing any of your hard-earned cash at that moment.

Long-term Cost

If you constantly carry a balance on your credit cards and your interest rates are high, you may end up paying the credit card companies two or three times the amount of what you actually purchased. If you only make the minimum payments, the amount you actually repay could be even higher and it may take years for you to get out of debt, if at all.

Debt Overload

The "buy now, pay later" mentality that is associated with credit cards can lead to serious debt overload if you're not using your credit wisely. If you're continuously charging things to your credit cards and don't pay them in full each month or you find yourself opening new lines of credit because your cards are maxed out, you run the risk of a financial meltdown when you can no longer maintain payments on your mountain of debt.

Impact on Financial Goals

The money you're using each month to pay your credit card bills is money that could be going to building savings or advancing other financial goals. Rather than paying a credit card company exorbitant interest rates, you could be using that money to save for retirement, plan your dream vacation, or buy a home. Overusing or misusing credit cards can essentially determine the quality of your current and future lifestyle.