Almost every day, I’ll get an email or two from a reader wanting me to evaluate a particular credit card with a rewards program associated with it.

“Is the Chase Amazon card a good deal?”

“Does that Target Visa really pay off?”

“Is the points program on this card better than the points program on this other card?”

Here’s the deal: the same exact set of ideas govern how I would answer all of these questions – and many more questions like them. It also governs how I handle my own reward credit cards.

Ready?

It doesn’t matter what rewards card you have if you’re carrying a balance. Let me repeat that. The reward program for your card doesn’t matter at all if you’re carrying a balance on it. What matters in that case, far above all else, is the interest rate on the card.

Ideally, you’ll never carry a monthly balance on a credit card. That’s what I’ve managed to do for the last several years, to my own relief. A balance on a credit card means that you’re going to be paying interest to the credit card issuer at an interest rate designated by them. You don’t want to be doing that, because that interest rate is often a painful one.

However, I know that many people do carry balances on their card. If you’re in that boat, the number one factor you need to be looking at – by far – is the interest rate on your card. The rewards program is of tiny consequence next to the interest rate. A card with no rewards program that offers a 7.9% APR is far better than the best rewards program out there on a card that has a 14.9% APR if you’re carrying a balance.

Once you’re past that step and aren’t carrying a balance on a card, it’s worthwhile to note that the best rewards program is the one that’s effortless for you. In other words, it’s the one that most closely matches what you buy and where you buy it.

For example, if your grocery store that you shop at every week has a credit card offer, it should go right to the top of your list, simply because such a card will often offer in-house rewards that will defeat almost anything else you can get. If your gas station that you always fill up at has a credit card offer, you’ll want to look at that one first, too.

It’s not too hard, with the right card, to get a 6% or 7% return on your card use (assuming, of course, you pay off your balance in full each month).

I’ll use a simple example. Let’s say you do your grocery shopping, department store shopping, and pharmacy business at your local Super Target. The Target Visa gives you 5% off on all purchases. On top of that, when you fill ten prescriptions using that card, you receive an additional certificate giving you another 5% off of your purchases for a single day. With some planning, that’s easily going to be 6% off your spending at that store. (However, it doesn’t save you a bit when shopping elsewhere.)

There are many similar cards tied to specific retailers. For example, if you live in an area where your local BP station offers the best gas prices, a BP Visa card will give you a 5% rebate on all gas purchased there.

The rewards on cards like these, when matched with a retailer you already use, is far ahead of the rewards you can get on non-specific cards. The advantage with cards like these is that you don’t have to do any planning or any extra purchasing to get the rewards. They’re just already in line with what you do.

What if you truly don’t have any cards available that match your regular retailers? To be honest, most of the non-specific programs are pretty similar. The best ones offer a reward of around 2% of your purchases and sometimes include a small signup bonus (some include a larger signup bonus, but with restrictions).

This brings me to my third point. No rewards card is worth buying stuff you wouldn’t already buy. If you have to make qualifying purchases, start shopping at a different store, or have to spend a specific amount each month, just skip the program. The cost and effort associated with having your spending dictated by a company exceeds any rewards.

So, if you want to find the best rewards program, do three things. First, don’t carry a balance on your card or else you’re just wasting your time. Second, choose cards in line with how you already shop. Third, avoid cards that require you to buy more stuff or shop in different places. If you follow these three guidelines, you’ll quickly arrive at the right rewards card for your situation.

Jennifer writes in:

Yesterday, I received a notice from [my credit card company] that my credit limit had been lowered from $10,000 to $4,000 on my primary credit card. I was immediately worried that my credit had been damaged by identity theft, so I checked it on annualcreditreport.com and there was nothing there at all. I’ve always paid all of my bills on time and my life has been pretty much normal and unchanged for a long time. Why would they make this change? I’m not concerned about reaching my credit limit, but that reduction in my limit does alter my debt-to-credit ratio, which could negatively impact my credit rating.

Jennifer describes a pretty typical scenario today. A credit card company sends a letter out of nowhere, for no obvious reason, announcing a significant drop in one’s credit limit.

One big effect that such a drop has is that it alters your debt-to-credit ratio, as Jennifer mentions. Simply put, your debt-to-credit ratio tells what percentage of your credit limit across all of your credit cards you’re actually using. So, let’s say Jennifer had a $3,000 balance on her $10,000 card – that’s a 30% debt-to-credit ratio. When the company drops her credit limit, she then had a $3,000 balance on a $4,000 card – that’s a 75% debt-to-credit ratio. The higher your debt-to-credit ratio, the more negative impact it has on your credit score.

This type of behavior seems alien, particularly after a decade where credit card issuers would commonly raise credit limits without you even asking. What gives?

The reality of the credit card industry has changed. For one, the econmic downturn has seen a large spike in the number of people who have simply defaulted on their credit card bills, not bothering to pay them. For another, the Credit Cardholders’ Bill of Right Act recently became the law of the land, restricting some of the business practices of the credit card companies.

Credit limits are not a right. Another issue is that many people, particularly after the last decade of rampant growth in credit limits, view their limits as something of a right and when credit card companies reduce those limits, their rights are somehow being infringed. In truth, that’s not the case at all – your cardholder agreement makes it very clear that your credit limit and your interest rate can be changed at any time.

So how do they decide when to lower your limit?

They watch what you buy via data mining. Every time you make a credit card purchase, the credit card issuer’s computers store a record of that purchase (you’ll see such information on your bill). Obviously, this is a wealth of information, one that they can use to figure out all sorts of things, such as where you live (so that if you suddenly make a rash of purchases elsewhere, they can throw a block on the card).

They draw conclusions based on what you buy. Another thing that they do is watch what you buy. They look at the places you normally shop and draw conclusions based on that.

Let’s say Jennifer normally shops for clothing at, say, Banana Republic (I don’t know this, I’m just creating a hypothetical example). Based on this, the credit card company would conclude that she fits the profile of an average Banana Republic customer, meaning she has a fair amount of discretionary income.

Now, let’s say Jennifer is suddenly a bit worried about the economy. She and her husband decide to curb their spending and she starts doing things like buying soap at the dollar store with her credit card.

When the credit card company analyzes the data, looking for spending changes that might affect credit limits, they’ll observe from their data that Jennifer is spending a lot less at the Banana Republic and a lot more at the dollar store. That means she’s got a different spending profile – one that signifies the potential for financial trouble.

They act in accordance to those conclusions. Given their recent problems with people defaulting on credit card debt, they take pre-emptive action and reduce her credit limit.

To Jennifer, this seems sudden and unfair – and for good reason. She’s likely not in any true financial trouble at all and is simply choosing to be a bit thrifty in these uncertain times.

What can you do to protect yourself? The truth is that Jennifer should avoid being in any kind of position where such a credit limit change has any impact at all on her. In other words, don’t be reliant on that piece of plastic. Use it as a tool instead of as something you need to have.

One big way to do that is to never carry a balance on your card. If a bill comes at the end of the month, pay it off. If you’re thinking of making a purchase where you wouldn’t be able to do that, you can’t afford that purchase. Wait a few months and save up the cash.

This not only keeps your debt-to-credit ratio pretty low, but it also leaves you out of any sort of “danger” from the credit card company adjusting your limits or your interest rates. More importantly, though, it prevents you from building up a significant amount of debt on the card, which can be very, very difficult to pay off.

Use your credit cards wisely and changes like what happened to Jennifer will have little or no impact on your life.

Earlier today, I read with interest the comments on this Get Rich Slowly article about Suze Orman and the “cash only” movement. In a nutshell, the article advocated (as Suze apparently does now) that people should abandon credit cards because the credit card issuers have been raising interest rates.

To put it simply, the raising of credit card rates shouldn’t matter to a person who has control over their financial life. If you don’t carry a balance on your credit card for longer than the grace period, it doesn’t matter what the interest rate is.

Based on the comments I read there, a lot of people do the same exact thing I do. I use credit cards for their convenience and the rewards they provide. I pay off the balance in full each month (I pay all such bills on the 1st and 15th of each month, actually, to keep it simple).

There’s one big problem with this plan, some will point out. It puts you at risk. What happens if you can’t pay the balance at the end of the month?

For starters, I never, ever carry a balance that’s more than what I have in cash in my emergency fund. I never even come remotely close. In fact, I never come remotely close to carrying a balance that’s more than what’s in my checking account. If I’m turning to my emergency fund, it’s a genuine emergency, not just a great sale at the store.

Which brings me to the second point – effective credit card use requires a lot of self-control. I am speaking from experience here – I learned the hard way about what damage a credit card can do if you don’t have self-control. It took a mountain of debt and a point that was perilously close to personal bankruptcy (while having a baby at home, no less) to force me to wake up to the truth – that a credit card without self-control is like a chainsaw in the hands of a toddler.

If you aren’t spending less than you earn month in and month out, you should go cash only, because cash provides the hard limits that are needed when you don’t have your spending under control. Credit cards are only beneficial to people who spend less than they earn every month, like clockwork. If you can’t or aren’t doing that, the drawbacks far outweigh the benefits for credit card use.

When the credit card companies raise interest rates, it’s not the financially stable people who are punished – they are often barely aware of rate changes because they’re unaffected by the changes. Instead, it’s the people who don’t have self-control – the people who carry a balance – who are punished by the changes.

Yet again, it’s a fantastic argument for living frugally, responsibly, and below your means – if you do so, the games companies play with credit card rates don’t affect you.

If you’re carrying a balance right now and your credit card company has just adujsted your rates, I have a simple plan for you: cut up your credit card. It’s doing you much more harm than good right now. Then, focus intensely on paying off the debt. Absorb as many frugality ideas as you can and try them in your own life. Knock down your life’s routines and build new ones – your old routines are the ones that brought you to this point. Seek out friends who don’t find their self-worth in the things they have. Seek out activities that don’t drain your wallet.

And gradually, you’ll find that credit cards don’t have to be dangerous – they can merely be useful tools – and that you don’t have to worry about rate changes.

Good luck.

You’ve finally paid off that credit card. It’s sitting there with no balance on it and you regret ever owning it. It’s got a high interest rate and no rewards program and you will never use it again.

But should you close it? This is an interesting debate that often comes up in personal finance circles. I think there are benefits and drawbacks no matter which you choose and the “best” answer isn’t absolute in all cases.

So let’s dig in.

If you keep the card…
If you decide to keep the card, there are a few things you should think about.

First, simply having the card is a small identity theft risk. If you’re no longer actively using the card, the risk is pretty small, and you can make the risk even smaller by taking action.

Second, not closing the card opens the door to spending temptation. Obviously, if you have the strength of character to pay off all of that debt, you’re able to keep the temptation in check.

There are two big steps you can take to reduce the two risks above even more, chopping them down to an incredibly tiny sliver.

For one, destroy the physical card. Cut it up so that there’s no risk of losing it or having it stolen. I tend to actually melt used credit cards over an open fire (seriously – I’ll toss them into campfires).

For another, remove your credit card information from any online retailers that may still have it. Check your Amazon account or any other retailers you might use and make sure your zero balance card isn’t listed there. Just get the information completely out of the system.

If you cancel the card…
Let’s say you decide to cancel the card. What are the drawbacks of canceling it?

The big one is that canceling a card results in a negative bump on your credit score. This negative bump goes away after roughly a year, but during that year, your lower credit score can have some short-term negative implications. It can cause your insurance rates to go up. It can reduce your chances for getting work.

The big one, though, is that it can also hurt you if you’re attempting to get a mortgage. A lower credit rating right at the time when you’re attempting to secure a home mortgage is not a good choice.

So what should I do?
From my perspective, the answer is simple. Before you do anything, ask yourself if you’re going to be changing jobs or getting a mortgage or a car loan in the next year.

If you’re looking forward to a major move like this in the short term, don’t cancel the card. The risk of the short term drop in your credit rating is higher than the risk of just cutting up the card and forgetting about it.

Instead, cut up the card, but hold onto the account until you’re past that hump that you’re facing in the short term. When you’ve made it, then make the call and cancel that credit card.

On the other hand, if you don’t see a major move in your future, cancel that card. Doing so eliminates the temptation and eliminates the (small) chance of identity theft.

Samantha writes in:

I don’t understand why I need credit at all. Credit just gets you into debt and you wind up paying interest to other companies. What’s the point of throwing my money away like that?

Samantha asks a really good question here – and in some respects, she’s spot on. Poor use of credit is a big net loss for people. Because of the interest payments, you lose far more than you gain.

However, there are a lot of upsides to healthy use of credit.

First, a good credit rating helps your insurance rates. Insurance companies use your credit rating as a factor in determining what sort of rate to offer you on homeowners insurance, auto insurance, and life insurance. The higher your credit rating – meaning the more reliable you are at obtaining credit, then paying the bills faithfully – the better you seem as a risk, because people with high credit are statistically more likely to be safe drivers, safe homeowners, and likely to live longer.

Second, a good credit rating helps you with employment options. Similarly, many employers run credit checks on potential employees and, again, are much more likely to hire people with strong credit because it’s a clear indication that they’re reliable.

Third, credit often offers great buyer protection. If you use credit to make a purchase – particularly credit cards – the cards offer a lot of protection against fraud, identity theft, and other serious problems. If you pay cash, you miss out on those protections.

Fourth, a good credit rating helps you with renting. Even if you’ve made the decision to entirely avoid credit and rent until you can write a check for a home, your credit still affects your housing because many landlords – particularly those in charge of higher-end housing – will check the credit ratings of potential renters and will reject (or charge a much higher deposit) people who have no credit or poor credit.

In the end, it pays to have a strong positive credit rating. This does not imply, however, that it’s good to be in debt. You can have a great credit rating without digging yourself into debt. Here’s how.

First, get a credit card. If you have no credit history, you can usually get one with a low credit limit pretty easily. Look for one that has some sort of bonus connected to a retailer you use. If you shop at Target, get the Target Visa. If you shop at Amazon, get the Amazon Visa. If you get all your gas at BP, get the BP card.

Second, use the credit card for routine purchases. If you stop for gas, use your card and pay at the pump. If you’re at the store buying some items you need and would buy normally, use your card for that routine purchase. Other than these events, forget about the card entirely.

Then pay off your bill in full each month. If you stick to just using the card for routine purchases, you should have no problem whatsoever paying off your entire bill each month. Thus, you never incur debt that generates interest.

Instead, you get all the benefits of a positive credit rating – lower interest rates, better job application success, buyer protection on some purchases, and better housing opportunities – plus the benefits of the rewards of a good credit card – discounts at the retailers you already use. Together, these add up to a net positive, and if you’re disciplined enough to keep yourself from using the credit card for purchases you would not make without it, it’s nothing but a positive.

Here’s another way to think about it. Your credit rating is simply the method many businesses use to figure out if you’re reliable or trustworthy. If you are, they see you as having more value – you’re likely to be a better employee, you’re less likely to have insurance claims, and you’re more likely to pay your rent. By avoiding credit, you’re sending no signal at all to them – and thus they’re unable to decide if you’re reliable or not and thus won’t offer you the best rates.

Positive credit helps you in many ways and saves you money consistently. Don’t avoid all credit because of a fear of debt – responsible people can enjoy all the benefits of good credit without the drawbacks of bad debt.

Good luck.

On Tuesday, the Senate passed the Credit Cardholders’ Bill of Rights Act of 2009, an act that will quickly be passed into law with the signature of President Obama, likely within the week. This bill has a huge number of ramifications for credit cards – for users who are late on their payments, for those who pay their bills on time, and perhaps even for the ability to use credit cards in stores.

Washington Wire summarizes the bill very succinctly:

Existing balances: Issuers cannot retroactively change the rate on an existing balance unless the account is 60 days delinquent.
Payments: A consumer payment above the minimum applies first to the balance with the highest rate.
Teaser rates: Issuers cannot raise rates for the first year after an account opened. Promotional rates must last at least six months.
Bills: Issuers must send a bill 21 days before the due date.
Over limit: Issuers cannot charge over-limit fees on credit cards unless the consumer has signed up to allow such transactions.
Minors: For consumers under 21 years old, a company must get the signature of a parent or another to take responsibility for the debt, or it must obtain proof that the under-21 consumer can repay credit.
Disclosure: Cardholders must get 45 days notice of change in terms.
Fees: Issuers cannot charge fees to pay by mail, phone, and electronic transfer or online, except for expedited service.
Gift cards: All gift cards must have at least a five-year life.

Meanwhile, The Wallet offers a few predictions for what this means:

“We’re in uncharted territory here,” says Curtis Arnold, head of CardRatings.com, a credit-card comparison site. Mr. Arnold says consumers can expect issuers to work overtime to lure high-end, high-volume clientele while adding fees and rate hikes for customers with less-than-stellar credit profiles.

The rationale is that credit-card issuers make money off interchange fees (fees merchants pay to card issuers). So customers who charge everything and pay off their balances are seen as less risky and still profitable by card issuers.

The future of rewards programs is also up in the air. Mr. Arnold advises cashing in reward and airline mile points, as their purchasing power has been on the decline in the last year or so. However, he points to new cards from brokerages like Charles Schwab and Fidelity, which offer higher cash-back rewards that lure customers to their brokerage products.

Mr. Arnold also advises those customers with existing balances to pay them off as soon as possible and consider transferring them to smaller banks and credit unions, which may be able to offer more generous rates and repayment terms. He, and others in the industry, expect interest rates on existing balances to keep climbing before the proposed legislation kicks in. (An optimistic guess would be that card issuers would have to comply nine months or a year from now.)

Something else to keep an eye on: Annual fees. The era of reward cards, or even non-reward cards, with no annual fees may be at an end. Stay tuned to notices from your card issuers and the changing fine print of your statement

So what does this mean for you?

First of all, these rules do help people avoid getting into trouble with credit cards. I applaud the change that requires minors to get parental approval or to prove they have the ability to repay before getting a card. I also like that all extra payments always go to the portion of the balance with the highest interest rate – no more shenanigans with companies applying overpayments to 0% balance transfers. Eliminating fees for different types of payment is also a plus.

But what else will change? It’s important to remember that the full ramifications of this bill won’t be seen immediately. Obviously, the credit card companies will try to keep their level of profits the same, which means that, inevitably, they’ll have to change their business in some ways. However, as Arnold noted above, they don’t want to kill the golden goose – the interchange fees that they rake in as a result of wide credit card use.

So, beyond the immediate impact for credit card users noted above, I’m going to make a few predictions about how this bill will affect things over the long term.

Interest rates will keep climbing. The days of easy low-interest credit are ending. That means the role of the credit card will begin to change as smart consumers begin to use credit cards more like charge cards – they pay off the balance in full at the end of each month.

What this might mean for you: Paying down your credit card balances as soon as possible is more important than ever! If you’re carrying a credit card balance, now is the time to start buckling down and wiping out that debt. If you aren’t carrying a debt on your cards, don’t start one – stick to spending less than you earn and keep using the credit card as an intelligent tool.

The credit card syndicates (Visa, Mastercard, etc.) will seek to raise interchange fees as a first line of attack. Credit cards work most effectively when lots of consumers have them and then expect this service from merchants. Think about it from Target’s perspective, for example – if half of their customers use credit cards to pay, they’re somewhat tied to offering that service to customers. Thus, I predict credit card companies will use that to their advantage and raise interchange fees, particularly on large retailers.

What this might mean for you: Many merchants will attempt to recoup this increase in interchange fees by passing the cost along to the consumer, so I would expect a slight bump in prices – 1% or so, spread out over many purchases and items. For most people, this will largely go unnoticed and will be seen as normal inflation.

Credit card issuers will get clever with fees, but annual fees won’t return. Most consumers have come to expect that their credit card will have no annual fees, so I don’t believe these will return in wide use. Instead, the companies will see other avenues for fees – cards that require a minimum number of uses per month, cards that have fees to enroll in particular rewards programs, and so on.

What this might mean for you: You’ll have to be more careful with credit card offers in the future. Also, when there are updates to your terms, you’ll need to read them carefully. Again, if you keep your balance paid, your credit will be good, so you can walk away from any cards that try to slip sneaky fees in on you.

I don’t believe rewards programs will go away. I would expect, though, that rewards programs will become more tied to specific “partner” retailers, like Target and Amazon, and away from more general programs like Drivers’ Edge. Why? Merchant-specific cards encourage loyalty to those merchants, and that has quite a bit of value to the merchants – those aren’t programs they will want to see go away.

What this might mean for you: Don’t be surprised if you find some of your rewards programs changing, particularly when your current card expires. For now, though, stick with what works for you.

Any thoughts or predictions on this new world of credit card rules?

A reader recently pointed me towards an interesting article at MSN MoneyCentral on the topic of restricting the access that teenagers have to credit cards. Much of the article discusses the proposed Credit Card Accountability, Responsibility, and Disclosure Act of 2009 (S. 414, sponsored by Chris Dodd, and often called the Credit CARD Act of 2009), which Weston summarizes as such:

The Credit Card Accountability, Responsibility, and Disclosure Act of 2009 would forbid card issuers from opening accounts for people under 21 unless one of these criteria is met:
+ A parent, guardian or other responsible individual agrees to co-sign for the debt.
+ The applicant provides proof he or she can independently repay the debt.
+ Proof is provided that the applicant has completed a certified financial literacy course.

I understand where this bill is coming from and I agree with it in large part, but I would be opposed to it overall. Let’s look at both sides of the coin.

What I Like About the Bill
When I was a new college freshman, I signed up for a credit card in exchange for a t-shirt, then I began to use it for all kinds of stuff – video games and so on. In short, I acted like a fool with that credit card – a card I would have never had if this act had been in place.

A bill like this would unquestionably have kept me from getting into this early credit card debt. My parents would not have signed off on such a card and thus I would have been forced to learn how to manage the money from my part-time job more carefully, teaching me some valuable budgeting lessons.

I also strongly agree with the idea of basic financial literacy being a requirement for credit card use, though I’m not convinced at all that this is the way to do it.

What I Don’t Like About the Bill
What I don’t like about the bill is that it takes away personal responsibility in two different ways.

On one side of the coin is the fact that many people under the age of 21 are fully independent and have their head on their shoulders. One individual I know had a very successful business he was running himself at age nineteen. I know several others who have been through trade school and are embarking on plumbing and electrical careers at that age. Why should these independent and self-motivated individuals be required to find someone to co-sign with them for a credit card?

On the other side of the coin is the lessons learned from credit card ownership, which might actually be easier before age twenty one for many. I didn’t figure out how to use credit cards sensibly until age twenty seven, but I’ll be the first to admit that I didn’t receive a great education on how to use them and what their role should be in your life. If I had, I might have been able to make sense of my earliest credit card troubles (when I was in college) when the amount of debt wasn’t that much at all. For many people, college is a time to learn and make mistakes and grow – this bill just offers more hand-holding.

For me, the negatives of this bill outweigh the positives.

Is There A Better Solution?
The solution needed here is pretty simple – there is a desperate need for better consumer education. Consumer education should be a part of the school system from the earliest stages. Reading, writing, and arithmetic are fundamental, but so is managing your money – not knowing how to do that in the modern world can derail your life.

Instead of sponsoring bills that restrict the freedoms of adults, why not invest a bit more in education and a bit less in other areas?

What do you think? Is the Credit CARD Act of 2009 a good thing or a bad thing on the whole?

A very long time ago, I wrote an extremely brief article covering the difference between charge cards and credit cards. That article really didn’t answer the question, though, because I still have conversations and receive emails where people use the phrases “charge card” and “credit card” interchangeably.

Along those same lines, Tim writes in recently:

Am I better off using a charge card or a credit card for buying stuff?

At first, I just assumed that Tim had replaced “credit card” with “charge card” in his vocabulary and I began to answer that question, but then I realized that it’s worthwhile to distinguish between all three types of cards and their advantages and disadvantages. So let’s go through them one by one.

Credit Cards
A credit card is borrowed money. When a company issues you a credit card, you’re given a specific credit limit – the maximum amount you can borrow from the company. Each time you use the card, you borrow some amount from that company, and each month, you’re required to pay back a portion of that amount to the company. Mastercard, Visa, and Discover are the major types of credit cards.

Advantages The biggest advantage of a credit card is the flexibility. You can make purchases without actually having the cash on hand at the moment. You also have an indefinite amount of time to pay back that money, though you do have to make a minimum payment each month on what you owe. Many credit cards also have rewards programs, which return to you 2-3% of your purchase price in some form or another – often in the form of gift certificates or rewards programs. Also, good credit card use helps you to build a good credit report, which can save you money on insurance and help you with loans. Consumer protection with credit cards is usually pretty strong, too – they’ll often help you deal with fraudulent purchases and don’t leave you out to dry if you lose the card.

Disadvantages The big disadvantage is that all the flexibility is a double-edged sword. The ease of use of credit cards and the lack of pressure to pay off what you owe makes it very easy to make poor purchasing decisions. Then, when you can’t pay off the card, you usually pay a hefty amount of interest on that unpaid amount – and over a long period, that interest can be incredibly costly.

Debit Cards
A debit card, on the other hand, is linked to your checking or savings account. Each time you use the card, money is automatically taken from your checking or savings account to cover the purchase. Many debit cards have the same purchasing flexibility as credit cards, as many are accepted where Visa and Mastercard are.

Advantages You can’t get into debt trouble with a debit card. It does not allow you to buy things that you don’t have the money for. For people struggling with debt, this is a huge advantage because it keeps you out of trouble. Plus, they’re flexible and convenient for day-to-day purchases. You also don’t have to have good credit to get a debit card – you often get one with your checking account.

Disadvantages The biggest disadvantage is that you have to keep a very close eye on your account balances, because you can overdraft your account if you’re not careful. Another disadvantage is that very few debit cards have rewards programs of any kind. Debit cards often don’t have the same consumer protections that credit cards and charge cards have – if your card is stolen, your protection against unauthorized purchases can be weak.

Charge Cards
Charge cards are often confused with credit cards, but they actually function in a fairly different fashion. Like credit cards, charge cards extend credit to you from the issuer, but you’re required to pay the full balance at the end of the month. Some charge cards also have an annual membership fee. Charge cards are typically associated with American Express; many store chains often issue their own charge cards as well which can only be used at that store.

Advantages You don’t have to have the money on hand for a purchase with a charge card, nor do you run the risk of carrying a balance that will charge you interest. Many charge cards have tremendous bonus programs that go from things like 5% cash back to free companion flights on airlines – their bonus programs are typically better than bonus programs for credit cards. Charge cards often come with additional services and benefits, like free roadside assistance, free food at airports, and free hotel room upgrades. They also help your credit much as a credit card does. Most charge cards offer strong consumer protection as well, similar to that of credit cards.

Disadvantages Some charge cards have an annual fee which eats away at the benefits from using it. Also, since you are operating on credit, there is some risk that you might build up a large balance on the card that will be difficult to pay off. Many charge cards are usually pretty strict in terms of who they’re issued to – you need to have good credit before even getting one.

Which One Is Right For Me?
Many people wish to avoid credit at all costs because of the risk of debt – in that case, a debit card is obviously the right choice. If you’re seeing a great debit card (preferably one that has some semblance of a rewards program), you should investigate all of the checking options available at your local bank and also perhaps do some shopping for a new bank, particularly if you’re unhappy with your current bank for some reason.

I tend to believe that it’s worthwhile for everyone to apply for at least a single credit card and use it irregularly. It provides a very easy way to build a positive credit report and gives you some flexibility in purchasing. If you have a good rewards card (for example, I use my Citi Driver’s Edge card for all gas purchases), you can also earn multiple percentage points back in rewards.

If you have excellent credit, have a strong policy of paying your balances back in full each month on your credit card, and travel a bit, it’s worth examining some of the charge card offers available to you, particularly if you’re running a small business. Typically, one can get a big net benefit from a good charge card, but you have to be aware of the benefits alloted to you by that card. Plus, you can’t get into revolving debt trouble with a charge card since you have to pay the balance in full each month. I know at least one small business owner who makes a killing with his charge card, getting tons of free flights, free airport foods, discounts on rental cars, roadside assistance, free hotel rooms, business advice, and so on, but those are rewards that others may have difficulty maximizing.

My suggestion, if you’ve never owned a card, is to get a good checking account (I use ING’s Electric Orange as my primary checking and I’m happy with them) and use their debit card for most purchases. At the same time, get a credit card, use it for only a few purchases, and leave the card at home so you’re not tempted to use it. This allows you to start building healthy credit without the debt risks of a credit card.

Please, readers, fill in additional details you see as important – many more people than just Tim will find use with this information.