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The reason for this post is because I came across an article by Michelle Singletary of the Washington Post titled, “Like it or not, it’s unwise to use credit.”  In her article she claims that, “we are all suckers – that is, losers – when we use credit to pay for services and goods.”  She has a point if she is referring to those that run up large credit card balances and pay the minimums each month.  People who exhibit that behavior are hurt because they end up paying a lot more for the products or services than the list price due to accrued interest and various finance charges from credit card issuer.  However, she was referring to everybody that uses a credit card, even the responsible ones.

The basis for her argument is the conclusion from two studies by researchers at the Massachusetts Institute of Technology and the University of Warwick.  The results from the MIT study say that people paid more when using a credit card than with cash.  The University of Warwick study also concluded that in similar purchasing situations, people spent more using credit cards than cash or checks.  While these studies definitely describe a certain segment of consumers, it is still wrong for the author to make the blanket statement that all people who use credit to pay for services and goods are “suckers.”

While credit card issuers often face criticism for some of their unscrupulous practices, they do offer consumers many benefits.  The first being is that if your card is lost or stolen, you can call the credit card company immediately and not be responsible for any charges an unauthorized user might have put on your card.  This is my favorite benefit that cards offer that has led me to rarely carry more than $20 in my wallet at any given time.  I sleep well at night knowing that if someone steals my wallet, I’ll only be out $20 in cash and the frustration of having to go to the department of motor vehicles to get a new license.

Another major benefit that many credit cards offer are rewards for using them.  I prefer cash back, American Express Blue Cash to be more specific.  I use this card for everything, saving money every time I use it.  Once I reach the second tier of rewards, I save 5% on gas.  My gas tank remains the same size, so it’s irrelevant whether I pay with cash or credit.

Credit cards also offer consumer protection.  If a credit card user purchased a good or service from a merchant that did not fulfill expectations, the user can contact the card company.  The company will then take up the battle with the merchant on your behalf.  One example of when using a credit card came in handy was when I purchased a text book online and was shipped the wrong one.  After contacting the seller numerous times to no avail, I was able to call my credit card company who then credited my account for the cost of the book.  If I had not used a credit card, I would have been out of luck.

While credit cards have a bad rap among many people, not all people that use them are “suckers.”  It is true that some people purchase more when using a credit card than when they use cash.  However, it is completely unfair to paint all card users with a broad brush and say they are fiscally irresponsible.  Credit cards are practical in many cases and if a person has enough self-control to use them properly, the benefits are enormous.  If you are a person that exhibits self-control, think about whether or not you would make a purchase if you were using cash, but continue to use credit cards and enjoy the immense benefits they offer.

I have about $29,000 in private student loans. I applied for a consolidation loan with Citibank. Once my credit was approved, Citi gave me the choice of 8% APR with a fixed rate or 6% APR with a variable rate. Which should I choose? – Steve, MA

Steve,
At first glance, the 6% annual percentage rate looks like the more attractive option because of its lower rate. However, this is variable which means the APR can increase over time, resulting in a higher monthly payment. This could catch you by surprise if you have not prepared for it. I would recommend the fixed 8% rate due to the fact that it gives you certainty when it comes to planning your finances in the future. You might question why I would recommend paying the higher rate, especially when paying 6% is more appealing than paying 8%. Assuming that there is no cap on your variable interest rate, it is a reasonable assumption that your APR could increase to 10% or higher and you will end up paying more.

In a related fixed vs variable rate situation, over the past five years, many homeowners took out “teaser” adjustable rate mortgages. These loans had lower interest rates than the prevailing fixed rates at the time. As a result, these ARMs made the payments more affordable at beginning of their terms. However, the party ended when interest rates increased and many of these homeowners were left unable to pay their mortgages. The moral of the story is that without being able to predict the future movements of interest rates, it is a safer bet to take the fixed rate over an adjustable one.

As an aside, one important thing to remember is that you are able to deduct student loan interest from your taxes if you meet certain criteria. For more information about deduction eligibility, please see Publication 970 on IRS’s website.

I recently acquired a little over a thousand dollars. I’ve been constantly hearing about Roth IRA’s and how they’re a really good option. What’s the difference between putting your money there versus putting it in a savings account? Should I even put my money in a Roth IRA? Thanks for your help. – Ryan, 22, Potomac, MD

Ryan,
Roth IRAs offer an attractive investment opportunity. The major benefit of Roth IRAs is that they offer an investor tax-free growth and withdrawals for all the contributions to, and gains in, the account. The major drawback is that every dollar contributed to a Roth IRA is after-tax and contributions are not tax deductible. The general rule is that if an investor is in a low tax bracket, a Roth IRA makes sense because there is the potential that in the future the investor will be in a higher tax bracket. On the opposite end, if a person is in a high tax bracket, they are probably better off investing in a traditional IRA because their contributions will reduce their taxable income.

There are a few differences between a Roth IRA and a savings account. With a Roth IRA, an investor can only contribute up to $5,000 in 2008 whereas savings accounts have no limit. In your situation, you have $1,000 so this presumably is not an issue. The major difference between the two is that the Roth IRA will offer you tax-free growth of your money, while you will get taxed on all interest earned from a savings account. The length of time you plan on not needing to access the $1,000 is the most important factor in your decision. Early non-qualified distributions (See IRS Publication 590 for all of the specifics) are taxed at 10%. Therefore, if you are absolutely sure that you will not need the $1,000 in the near future, I would recommend putting it into a Roth IRA. Otherwise, you are better off putting it into the savings account.

I am a 29 year old that recently switched jobs. I was wondering what I should do with my former employer’s 401(k)? Should I roll over into an IRA, and what are the benefits of rolling over?
- William, Pennsylvania

In nearly every circumstance I would recommend rolling over an old 401(k) into an individual retirement account (IRA). The reason being is because you have a lot more control over where you invest your money. Most 401(k)’s limit the number of investment options a plan participant can put their money in. Also, the mutual funds that many 401(k) plans offer are often loaded with high expense ratios and other hidden costs. As an individual investor, you have practically an unlimited amount of options. Unless your former employer’s 401(k) offers you attractive options that are not available to you outside of the plan, I would recommend rolling it over into an IRA at Vanguard (www.vanguard.com) or Fidelity (www.fidelity.com). Vanguard offers low-cost index mutual funds that outperform many of its actively managed peers. Fidelity offers a variety of mutual funds including similar low-cost index fund and it also has a brokerage where an investor can purchase individual stocks. As an added bonus, many mutual fund companies will handle the 401(k) rollover for you at no charge.