NOVEMBER 2006 :: CONSUMER ED

Dealing With Cards
Enjoy the Benefits Without Ruining Your Finances

By JEFF D. OPDYKE
Staff Reporter of The Wall Street Journal Classroom Edition

A credit card is a financial tool that allows you to purchase goods and services when you don't have the necessary cash on hand. And like any tool, a credit card can work productively or destructively.

A credit card can be an efficient way to spend, and in a society that increasingly is going cashless, having one has become a necessity. Just try reserving a car or booking a hotel room without a credit card these days. Of course, a credit card can also be an efficient way to satisfy wants you otherwise can't afford or that are a waste of your limited resources, thereby shriveling your net worth over time. That is the epitome of bad debt.

Adapted from "The Wall Street Journal Complete Personal Finance Guidebook" by Jeff D. Opdyke. Copyright 2006 by Dow Jones & Co. Published by Three Rivers Press, an imprint of the Crown Publishing Group, a division of Random House.

Free (Use of) Money

Here's how credit cards work:

A credit-card company fronts you the money for your purchase by promising to pay the retailer or the service provider the cost of whatever you've bought. In return you promise to repay the credit-card company the full amount. If you repay the money in full within 30 days, the credit-card company typically doesn't impose any interest charges. If you don't repay the entire amount, then interest begins to accrue on the outstanding balance.

If you repay all your balance in full each month, you have effectively gained access to free money. That's because the money you otherwise would have spent on groceries and gas and such is instead sitting in your bank account earning interest. That's a wise use of debt. (But do read the fine print on your contract; some card companies now charge a fee when you pay your balance in full each month because otherwise they get nothing from you for the use of their cash.)

Credit and charge cards come in several varieties, but the big three are American Express, Visa and MasterCard. Discover and Diner's Club have their followers, but those cards are also-rans at best. Though there are a small number of types of cards, there are literally thousands of versions floating around, all with different branding on the front and all with different costs, interest rates, fees and perks.

Some cards offer airline miles, with which you can obtain free airline tickets or hotel stays, saving potentially thousands of dollars in airfare or vacation costs. Some cards offer rebates, returning money to you at the end of the year or credits for free gas or discounts on a new car. Some cards contribute money to a college savings plan, essentially helping your family fund some portion of your future college bill just by spending money on the everyday things they have to buy anyway, such as the week's groceries.

All of those can prove smart uses of debt as long as you're not accumulating interest charges and you're not overspending. The smartest credit-card consumers are those who know they can afford to pay cash for what they're buying but choose to use a credit card for some added benefit they're getting, whether it's free use of the credit-card company's money or airline miles.

A Basket of Receipts

Consumers go astray when they rely on credit cards to live a lifestyle their income can't support. If you can't afford those purchases with the cash in your checking account, then you can't afford those purchases. It's as simple as that.

Prudently using a credit card means paying attention to how much debt you're racking up in charges so that you have enough cash from your monthly income to pay the bill when it arrives. You never want to fall into the habit of routinely drawing down your savings to pay a credit-card bill; in that event, all you're doing is consuming your assets and exchanging them for items that don't hold any value.

To keep better track of your monthly spending, set aside a basket, a drawer, a bowl, or whatever works best for you, and toss into it every receipt you accumulate each day. Keep a running tally of the charges on a piece of paper. You'll see exactly how much you're on the hook for, a visual reminder that will likely keep you from overspending.

This serves a security purpose as well. If your bill shows you owe more than your tally says you owe, you either forgot to record an expense or someone has fraudulently tapped into your account, and by quickly noticing the added charge, you can alert the credit-card company.

Equally convenient is routinely visiting your credit-card company's Web site; most likely it is printed on the back of your card and certainly it is on the monthly statement. You can see exactly how much you owe at any given moment, though your most recent charges might not be in the system yet.

Remember this: When it comes to debt, particularly from a credit card, it's your spending, not your income, that ultimately determines your wealth. You can save all you want, but if you have an untamed credit-card habit, all that money-and more-will wind up on the profit line of your credit-card company.

Should credit cards be widely available to high school students? Write to letters.classroom@wsj.com.