Charge Cards Vs Credit Cards: You Decide

photo: Andres Rueda

It’s been a raging debate for decades: should I pay for that iPad with my charge card or with my credit card?  OK, so I exaggerated the history of the debate, but despite my sarcasm it is a valid discussion.  Which is the better slice of plastic, the charge card or the credit card?

As I like to do before I dive in, I’ll define each of the two.

A charge card looks exactly like a credit card in shape, size and usability, but that’s where the similarities end.  Charge cards do not have credit limits, so theoretically you can charge as much as you want, until the issuer decides enough is enough.  That’s because, despite the lack of a credit limit, charge cards do have what is referred to as a “shadow limit,” or the upper boundary of your capacity to charge.  Also, charge cards must be paid in full each month, unless you have a hybrid card that allows you to choose between paying some of the balance.  Charge cards generally have annual fees because of the lack of interest income for the issuer.

A credit card does have a credit limit, which is the pre-set upper boundary of your capacity to charge.  Common credit limits for low-end credit cards can range from a few hundred dollars to a few thousand dollars.  Limits for higher-end cards (usually named for precious metals) can be as high as $10,000 to $30,000 or even more.  Credit cards do not have to be paid in full each month because you can “revolve” a balance from one month to the next.  The price for this is the interest you pay on the unpaid debt.  Credit cards don’t generally have annual fees because of the interest income, but we’re seeing more credit card issuers experiment with annual fees for holders who don’t generate much revenue.

The clear benefit of a charge card over credit is the fact that you’re less likely to get into crushing debt because you know that roughly 21 days after you receive your statement you’ll have to pay it in full.  And, charge cards are a decent way to establish, build and maintain solid credit histories and credit scores.  Note my use of the word “decent.”

The downside to charge cards, and it’s not a huge downside, is the lack of a set credit limit.  An important factor in your FICO® credit scores is what’s referred to as utilization, and it’s the relationship between your balances and your credit limits expressed as a percentage.  So, for example, a $1,000 balance on a credit card with a $10,000 credit limit equates to 10% utilization ($1,000/$10,000 = .1), which is very good.

But, in the absence of a credit limit most credit and insurance scoring models will use the “high balance” as a substitute.  And normally the high balance is lower than the credit limit. The impact of the lack of a true credit limit and the reliance on your high balance can be exaggerated especially if you have a young credit report with only a few accounts.

So, if your high balance in a similar charge card example is only $2,000, then some scoring models will interpret you as being 50% utilized ($1,000/$2,000 = .5), and that’s not good.  In fairness to all involved, the newer versions of credit scoring models do not include charge cards in the utilization calculations, but not all lenders are using the newer versions.

The downside to credit cards is the fact that you can get into a lot of debt in a short period of time.  And if you chose to revolve a balance from one month to the next while only making the minimum payment and continuing to use the card, you are headed for trouble.  Credit cards are often abused by those who consider them as income rather than as a method of convenient shopping.  The default rate on credit cards is north of 10% right now, which is troubling.

The upside to credit cards is the fact that they don’t usually have annual fees and you can still pay them in full each month, just like a charge card. And most credit card issuers do report your actual credit limit on your credit reports. (It’s important to note, though, that regardless of what your credit limit is, the most important factor is what the issuer is reporting to the credit bureaus.  Some credit card issuers do not report your credit limits.  The easy way to check is to look at your credit reports.)

I personally have several of each card type in my wallet.  I have them not because I like one type more than the other but more so because of my profession and I have to test drive these products if I want to intelligently write about them.  Your best option is going to be based on how you plan on using the card.  So choose wisely, my friends.

John Ulzheimer is the President of Consumer Education at SmartCredit.com, the credit blogger for Mint.com, and the author of the “credit history” definition on Wikipedia.  He is an expert on credit reporting, credit scoring and identity theft. Formerly of FICO, Equifax and Credit.com, John is the only recognized credit expert who actually comes from the credit industry.  He has served as a credit expert witness in more than 70 cases and has been qualified to testify in both Federal and State court on the topic of consumer credit.