When people hear the term credit cards, they’re normally terrified or ecstatic. That’s because they have the ability to be of huge benefit, or lead to financial downfall. We’ll talk about some strategies throughout this article that will help you figure this out.
How credit cards work
Once you’ve applied and been approved for a specific credit card, normally the likes of Visa, Mastercard, Discover, or American Express, you’ll receive that shiny new piece of plastic in the mail. Time to spend some money, right? Not so fast. First you should know how credit cards function.
Credit cards are a form of revolving credit. This means you get to borrow money up to your ‘credit limit’ which is set by the card company, and then you pay back the balance with interest (normally 7% or greater for most cards). As you pay the balance, you can continue to spend money on the card. But be careful, it’s not uncommon for a card to carry a 16-20% interest rate!
Using credit cards for daily spending
My wife and I use credit cards for all spending which accepts a credit card. We do this for a few reasons, but mostly to earn rewards on the money we would be spending regardless. For example, last year we opened a Discover It card, which gave us a match of our cash back for the entire first year of using the card. We earned $1,800 in cash back on this card alone!
The other major reason we use credit cards is for fraud protection. While a debit card is a direct link to your checking account, a credit card is not. Credit cards normally come with robust fraud protections, but you should confirm this prior to opening your own credit card account. Fraud is so rampant, that the Federal Trade Commission reported a 70% increase in fraud activity from 2020 to 2021. Don’t think it can’t happen to you.
Credit card rewards
By spending with credit cards, you open yourself up to all kinds of rewards such as free hotel stays, plane flights, discounts on concert and sports tickets, and more! Recently, I had accumulated 17 free nights at Hilton through credit card spending, bonuses, and some work travel. I’m using some of those free hotels to attend sporting events in the fall.
The other major reward is cash back, and who doesn’t like receiving cash? Basically, as you spend money your credit card accumulates a cash reward balance, normally 1.5 – 2% of spending, which you can apply to your statement or cash out depending on the lender. It’s never a bad idea to earn some spare cash while paying your bills, unless the merchant has a credit card processing fee that exceeds your reward amount.
The last reward isn’t immediate, but it is important. Your credit score will feel the impacts of proper credit card usage. If you continually use credit cards and carry a low balance, the credit bureaus will grade you on the percentage of credit lines you’re tapping. If this is under 10%, you’re doing great! If you carry a huge amount of credit card debt and/or start becoming delinquent, your score will negatively reflect that.
Less preferred credit card uses
While there are a ton of rewards to be had, there are also some common traps. One of these is making a huge purchase on a credit card while not having the money to pay it back. Let’s say you buy a vacation for your family that comes out to $10k. Even though you don’t have the money in savings, you figure it will be easy enough to pay back in a year or so. Well, even if you make $200 monthly payments with 15% interest, it will take 6 years and 7 months to pay off, while sending a whopping $5,700 in interest to the bank. Yes, you heard me correct. The $10k vacation cost you an extra $5,700 in interest. Effectively, any rewards you earned have been negated.
As you can see in the graphic above, courtesy of LendingTree, Americans are carrying a staggering amount of credit card debt. I don’t write this to be pessimistic about credit card use. But rather, as a cautionary tale. If you already have issues with over-spending, daily credit card usage may not be preferred for you. You need to assess your own spending habits and determine if this is a feasible strategy.
Picking the right credit card
I’m not going to make any specific recommendations on cards, because it is very personal. I will recommend a website that I use all the time, which is The Points Guy. They post tons of credit card reviews, and break down all the great deals. You’ll want to look for a card that matches your rewards goals. Maybe it’s cash back or maybe it’s travel. You might want access to an exclusive airport club for international travel. I don’t know, that’s why you should do some research and find out what you value the most in a card.
Budgeting for credit card usage
The hardest part of using a credit card for daily purchases is avoiding credit card creep, as I like to call it. This is where your spending slowly increases because you’re not getting immediate feedback. If you use a debit card, you’ll see that there is only $100 left in your account, so you have a warning that you should slow your spending. With a credit card, no such warning exists. This emphasizes the need for good budgeting, which you can read about in another piece I wrote a few months back.
Credit cards certainly have a lot of benefits, and some pitfalls as well. I hope you can find the happy medium that works best for you!