Editorial Policy

Credit cards vs. charge cards: which Is best?

Eva Norlyk Smith Ph.D.

September 11, 2013

The words “charge” and “credit” are often used synonymously, so it's easy to confuse charge cards and credit cards.

However, these two types of cards are actually very different payment instruments. While credit cards allow you to carry a balance into the next payment cycle (and pay interest for the privilege), charge cards require you to pay the entire balance by the end of the monthly billing cycle. That means no interest charges — but a much smaller window in which to pay the balance.

Before deciding which type of card is best for you, know these five points.

1. Charge cards require more discipline
Charge cards used to be called travel and entertainment cards, and they were mostly used for employee expenses that were paid off by employers each month. Nowadays, many consumers are using charge cards as well, says Mike Sullivan, director of education at Take Charge America.

“Unlike with a credit card, you typically can't carry a balance over from month to month,” Sullivan says. “So when you get a charge card, you need to make sure that you can pay it off every month. If you can't, that's probably not the best card to choose.”

While using a charge card instead of a credit card in theory would protect you from accumulating credit card debt, it can also backfire. Charge card holders who spend more than they can pay off at the end of the month may find themselves facing substantial penalty fees or have their accounts suspended.

That being said, because you are required to pay the balance off every month, charge cards can also be an excellent tool for building financial discipline. While credit cards are very forgiving of overspending, charge cards will punish you with steep penalty fees and high interest if you spend more than you can pay off at the end of the month. For that reason, if you have difficulty controlling spending, charge cards might just give you the tough-love training you need to build better payment habits.

2. No preset credit limit doesn't mean no limit
While credit cards come with a preset spending limit (the line of credit), charge cards do not. That doesn't mean, however, that you can charge an expensive vacation, fancy dinners and a new wardrobe the moment the charge card arrives in the mail. Charge card issuers generally set “flexible spending limits,” which are based on the cardholder's previous payment history, credit rating and estimated financial resources.

“If you get a charge card and try to charge large amounts, you will likely get a call from your card issuer,” Sullivan says. “You might even find that charges are declined after you get over a certain limit.”

Because you don't know what the limit is, this can be a bit disconcerting. Sullivan recommends starting small and giving the card issuer time to get to know you and your spending habits. That way, your limit will steadily increase over time. If you have a trip or other event coming up and anticipate spending more than usual, call the card issuer and warn it about the amount you expect to spend.

“Once you're established, the real limit is often pretty substantial,” Sullivan says. “I have charged well over five figures and had it accepted, but it takes time to build up to that. And, you still have to pay it off at the end of the month.”

3. Charge cards may impact credit scores differently
In the past, keeping high balances on a charge card could be bad news for your credit scores. Because there is no stated credit limit on charge cards, credit rating agencies instead used the highest monthly balance on the account as an arbitrary credit limit.

However, for people carrying the same average monthly balance each month, this artificially inflated the credit utilization, a component of credit scores that compares debt carried to credit available. Also known as debt-to-credit-limit ratio, this factor counts for 30 percent of FICO scores and 23 percent of Vantage Scores. Keeping that ratio low is necessary for maximizing credit scores.

Newer credit scoring models, such as FICO 2008, however, have changed the scoring to avoid penalizing people who use charge cards. However, many lenders still use older credit scoring models, and if a potential lender pulls a type of score that still includes charge card balances in its utilization calculations, your credit score could be affected.

This is a fine point, and mostly only relevant if you're looking to apply for a large mortgage loan. In all other respects, charge cards function like credit cards when it comes to building your credit record, in particular by contributing to payment history and credit variety.

4. Charge card rewards are generous, but can be expensive
Most charge cards offer rewards programs, and if you don't mind the steep annual fee, rewards are often more generous than for credit cards.

For a $450 annual fee, for example, the top-of-the-line Platinum Card from American Express gives you access to more than 600 airport lounges worldwide when you enroll in Priority Pass Select, as well as a $200 annual statement credit with the airline of your choice for use toward baggage fees and other assorted fees. Cardholders also enjoy concierge service for assistance with travel and reservations as well as access to special advance tickets for events.

While not all charge cards come with the same steep annual fee, expect to pay a considerable premium over typical rewards card annual fees.

5. Differences are smaller, but more important
Charge cards are becoming increasingly like credit cards. Some charge card programs now allow select, low-risk cardholders to carry a revolving balance, based on an evaluation of the cardholder's credit history and personal finances. American Express, for example, has a “Pay Over Time” feature for certain charges made on some of its charge cards. Terms for carrying a balance on a charge card are unique to each cardholder's situation and must be negotiated with the card issuer.

Carrying balances on a charge card is typically more expensive, however, compared to rolling over a balance on a credit card. Charge cards won't give you access to low-interest or 0 percent APR offers, perks that make credit cards such a useful resource for longer-term financing. Further, should you be unable to meet the card issuer's expectations for paying off the balance, the consequences can be severe.

“If you make a partial payment [on a charge card] and it's not permitted, you will get a letter and a new bill with interest added,” Sullivan says. “There's always a default interest rate that the card issuer will charge on any unpaid balance, and expect it to be substantial. In some cases, if you don't meet expectations, the card issuer might even close your account.”

Ultimately charge cards and credit cards each offer a variety of benefits. The trick to deciding is understanding your situation and being honest about your bill-paying habits. If you need to pay off purchases over the longer term and anticipate carrying a balance, a credit card is probably the best fit. If you can pay your bill in full every month without fail and want to be rewarded with extra perks, consider a charge card.