Behind the facade of no-limit credit cards
Credit and charge cards that have no preset spending limit aren't really a license to charge as much as you'd like, and they can damage your credit score.
This post comes from Odysseas Papadimitriou of CardHub.com.
To some people, the idea of a credit card that allows unlimited spending might sound too good to be true. To many others, it sounds too good to pass up. And to credit card companies, the illusion of a limitless spending vehicle is an extremely lucrative one.
It is therefore obvious why consumers are generally confused about the existence of such a credit card and why issuers are making no move to clear up this uncertainty. This also helps explain why the Visa Signature credit card, the World MasterCard credit card and the charge cards offered by Chase and American Express have become some of the most popular products for people with excellent credit. Post continues after video.
The myth of unlimited spending
People are attracted to these cards because of a feature known as "no preset spending limit" or NPSL, which alludes to the possibility of unlimited spending. However, what NPSL really means is that a card's limit is not static -- that it changes on a month-to-month basis depending on various factors such as spending and payment history.
Consumers are generally unaware of this reality, though, since credit card companies, for obvious reasons, do their best to perpetuate the myth of unlimited spending.
Issuers make a point not to notify customers about their NPSL cards' limits and even refrain from releasing them to the credit bureaus during the regular reporting of credit card information. Such secrecy can have many negative effects on users, ranging from an increased likelihood that your credit card will be declined unexpectedly to your credit score falling.
It's obvious why not knowing how much money you have at your disposal would increase your susceptibility to failed transactions, but why would secrecy about your available credit stand to hurt your credit standing?
Damage to your credit score
It does so by distorting credit utilization -- the measure of how much credit you use over a given period of time as compared with how much is available to you. According to an NPSL study conducted by CardHub.com, some issuers don't report limits for their NPSL cards, while others report arbitrary substitute amounts in the place of their cards' true working limits. Both methods preserve the myth of unlimited spending. Both create misleading perceptions of your credit utilization.
Because credit utilization is factored prominently into credit score calculations and its accuracy is obviously quite dependent on accurate credit limits, inaccurate reporting sets off a chain reaction that ultimately affects your credit score. But to what extent?
This question is effectively impossible to answer, partly because it is consumer-specific, and partly because it's difficult to figure out what issuers report to the bureaus. According to the Card Hub study, credit card companies could change their methods of reporting without notification, and some -- notably Chase, HSBC, and US Bank -- are not even transparent about their policies.
In addition, the ramifications of high credit utilization vary based on your credit history, number of credit cards, payment track record, etc.
What's a better choice?
The bottom line is that while spending within your means and making on-time payments are more important to a healthy credit score than what credit card you open, having an NPSL card doesn't help.
NPSL credit cards and charge cards merely represent high risks that don't provide much reward in return. In truth, uncertainty is the main feature of an NPSL card. As such, these cards should be universally avoided by the roughly 100 million American consumers with excellent credit.
After all, traditional rewards credit cards are far superior products for this consumer segment. Not only do they provide true tangible benefits, but their terms are also extremely clear -- a fact surely to be welcomed by anyone who has ever held the dubious distinction of being an NPSL card user.
More from MSN Money:
Copyright © 2013 Microsoft. All rights reserved.
Fundamental company data and historical chart data provided by Morningstar Inc. Real-time index quotes and delayed quotes supplied by Morningstar Inc. Quotes delayed by up to 15 minutes, except where indicated otherwise. Fund summary, fund performance and dividend data provided by Morningstar Inc. Analyst recommendations provided by Zacks Investment Research. StockScouter data provided by Verus Analytics. IPO data provided by Hoover's Inc. Index membership data provided by Morningstar Inc.
ABOUT SMART SPENDING
LATEST BLOG POSTS
The government's health care portal stumbled badly out of the gate 2 months ago, and it's still far from perfect.