The holidays are a distant memory and now that the bills have mounted, we find ourselves in need of a few things for that we’ve been neglecting. Maybe you can relate. Perhaps the new year brought with it a new job or some necessary home repairs, and you find yourself in need of a wardrobe makeover or some supplies from your neighborhood home-improvement store. Thanks to the holidays, you may be tapped out and tempted to open a department store or Home Depot card to make these necessary purchases.
To make this an even more tempting option, the cashier says, “Would you like to open up a store credit card today? You’ll get 15 percent off this purchase and a 10 percent discount every time you use it!” With a big smile and fingers hovering over the keyboard she says, “It’ll only take two minutes to get you approved and you can be on your way.”
What do you do?
Based on the figures, many people in this situation will say “yes.” The Nilson Report (an annually published report on the world’s top card issuers) confirms that private store credit cards made up over 7 percent of the total annual credit card debt carried in the United States. While 7 percent may sound insignificant, it accounted for over $184 billion in 2014 and was the third consecutive rise in store credit card debt in as many years.
A survey conducted by a popular credit card ranking service found that 9 of the top 20 most-used credit cards in the nation are store credit cards from retailers such as Sears, Macy’s, JCPenney, Kohl’s, and Walmart.
Is there really anything wrong with taking advantage of store credit cards, especially considering the discounts and perks they generally offer to sign up? Despite the appeal of these offers, there are at least five good reasons to steer clear of opening additional store credit card accounts this year:
Those discounts are only half the story
It is important to remember that retail stores are not in business to lose money. If they offer you a discount, it’s because they ran the numbers and know they can afford to do so, meaning you very well may be paying too much for your purchases to begin with.
To test this theory, before you get to the checkout line, take a few minutes to search online for the products you’re considering buying and see if they’re available elsewhere for less. In many cases, you can get the same exact item for a lower price, even factoring in shipping.
But, surely if they’re giving you 15 percent just for signing up, it’s worth it, right?
The discounts and perks are covered by the interest rate
Beyond the simple math, retail stores have also done their research and understand human nature and spending habits.
They know most Americans go overboard during the holidays, leaving them strapped in the early months of the new year and continuing to spend beyond their means. They also know it is highly unlikely that most of their customers will be able to pay off the balances they accrue within the first few months. Because of this, many of these store credit cards come with enticing introductory offers, including “zero interest for 3 months” or “no payments until…”
If you read the fine print, though, you’ll see that these too-good-to-be-true offers carry a dangerous caveat: If you don’t pay off the entire balance during the introductory period specified, ALL the interest you would have accrued on your full balance is instantly added to your debt.
Which brings us to a third serious consideration:
The interest rates are usually higher
In 2017, the average annual percentage rate (APR) for all credit cards issued in the United States hit an all-time high of 16.15 percent. In comparison, however, the average store credit card APR is 24.99 percent!
Based on a 24.99 percent APR, you would pay $125 for every $100 you spend on that card over the period of a year, causing the initial discount and other perks to lose their luster. It only takes a few months of minimum or no payments before your initial discount is completely erased and your higher-than-average interest continues to pile up.
That low credit limit hurts your credit score
Another danger that comes with store credit cards is the negative impact they can have on your credit score.
These instant-approval cards often only offer a few hundred dollars in available credit to begin with. Because of the low credit limit, your very first purchase is likely to use a significant portion of your available credit on that account.
Your credit utilization ratio is one of the factors used in determining your credit score, and the higher that ratio is, the more it tends to negatively impact your score. To avoid negative effects, you should be striving for a credit utilization ratio under 30 percent. However, if your Big Box Store Credit Card only has a $300 credit limit, that first purchase of $185 immediately puts you at a ratio of 62 percent.
By itself, one low-limit card with a high utilization ratio probably isn’t going to sink your credit. But, if you’ve been lured into signing up for this one, how many others do you already have in your wallet? It is important to know how much of your overall credit is made up of low limits, elevated interest rates, and high utilization ratios.
Store credit cards are designed to encourage overspending
Finally, let’s call these store credit cards out for what they really are: clever means used by retail stores to encourage their customers to overspend.
Even looking beyond the introductory promotions, the low credit limits and high interest rates, consider this: why are we hit with the credit card offer at the worst possible time for us to make a rational decision — either during or immediately after the holidays? During these times we may be mentally struggling with pulling out the cash or debit card to handle our purchase and that’s when we’re offered a shiny new piece of plastic that can make this entire situation faster, easier, and 100 percent pain free.
There’s a lot of psychology involved in how that’s set up. And, not surprisingly, if you’ve ever worked the cash register at one of these retailers, you know how hard they push the credit card offers. In many cases, employees can lose their jobs if they don’t rack up a high enough number of new accounts per week or month. That kind of pressure isn’t focused on your best interests or your long term financial health.
Credit should be a tool for strategic spending that’s part of a planned budget. Or, if absolutely necessary and with clear limitations, as a safety net when an emergency arises. Credit cards should be chosen wisely and should never be a vehicle for impulse purchases or a thoughtless add-on obtained for convenience.
As you’re weighing the need for the card, be aware of the potential harm store credit cards can do, and remember these five reasons why you should say, “no!”
The best way to understand how different types of accounts impact your credit score is to regularly review your credit report. If you’d like a free credit report summary and credit consultation, contact a credit repair company today.