Choosing Between A Credit Card and A Charge Card
2 Aug
A charge card may seem similar to a credit card in usability, size and shape, but that’s where all the similarities end. These cards don’t have credit limits, so in theory you are allowed to charge as much as possible, until the issuer determines that enough is enough. It must be paid in full at a certain date each month. Charge cards usually have annual fees because it gives no interest income to the issuer.
Credit cards use a limit, which is the predetermined upper boundary of your financial ability. Typical limits for a low-end credit card can range from $500 to less than $3000 thousand dollars, while for higher-end card, it can be more than $40,000.
The most obvious advantage of a charge card is that you are less likely to get into a debilitating debt because approximately three weeks after the statement is sent, you need to pay it in full. Overall, charge cards are a good tool to start, maintain and improve your credit history, provided that you use it sensibly.
Of course, charge cards also have a downside, it lacks a credit limit. An essential factor in the FICO credit scores is what is referred to as utilization, which defines the relationship between balance and credit limit expressed as a percentage. Say, you have $2,000 balance on your credit card that has a $30,000 credit limit, which equates to 6.6% utilization ($2,000/$30,000 = .1), which is excellent.
However, because charge cards don’t use credit limits, the scoring will use the “high balance” instead. And the high balance is usually less than credit limit. The impact of the reliance on your high balance and the lack of a real credit limit can be exaggerated particularly if you have a new credit report with only a couple of accounts.
So, if the high balance in your charge card is only $1500, then the scoring models will consider you as being 66% utilized ($1,000/$1,500 = .66), and that’s a bad news. In fairness to all involved, latest credit scoring models don’t include charge cards when calculating the utilizations, but your lender may still use the older version.
The benefit to credit cards is that they do not usually have annual fees and it is still possible pay in full each month, in a way you can treat it as a charge card with a limit.
In general, use a charge card, if you are sure that you can control yourself and have the ability to pay in full each month. Credit cards, especially those without annual fee is also a good idea, if you can accept the credit limit and understand about the risk of unmanageable debt.
