We’ve all heard a story about someone going in to significantcredit card debt, and then struggling to pay back their bills as the interestadds up. Credit cards carry a significant amount of risk for individuals whoaren’t able to keep their spending within a certain amount. It can be easy toput a large purchase on the credit card and forget about it until the billcomes due. So why does that stop so many people from using credit cards onregular purchases?
Thelogic I hear is pretty simple: If I use my debit card instead of my creditcard, I can only spend cash that I have today. Now let me be clear, this makesabsolute sense for those of us that are not able to maintain a budget. The goalis not to rack up a significant amount of debt and accrue interest. But forthose of us that can stick to a budget, a credit card offers some greatbenefits.
Numberone, you can get reward points on your purchases. This last weekend I was atCostco and they pulled me aside to talk about their Citi Visa Card. This cardoffers some great cash-back benefits: 4% on gas, 3% on travel and restaurants, 2%on everything at Costco, and 1% on everything else. Using this card as anexample, lets say you spend $400/month going out to eat, and another $200/monthon gas for your two cars. On just these two categories alone, you could bebringing in ~$240/year in rewards. This costs you absolutely nothing if you payyour card off every month and don’t accrue any interest. I’m not one to forgofree money, and neither should you!
Numbertwo, you have more protection if there is a fraudulent charge on your account. Theway a debit card works is the money is almost instantly taken from yourchecking account. That’s cash money and a potentially destructive balancereduction. Based on how most credit card transactions are routed, it cansometimes take several days for that charge to hit your account – and you’renot even responsible for paying this amount until you get your bill. It’s notfunneling cash from your account and putting you at risk. Federal law alsolimits your personal liability for fraudulent charges on a credit card to $50.This number goes up to $500 or more for debit cards. I’d much rather have acredit card number get stolen than a debit card number. The Target hack severalyears ago is a great example of why we should be cautious as to whatinformation we have out there.
Numberthree, there are other benefits you can get from having a credit card. Forexample, some credit cards will offer you free phone insurance just for usingthe card to pay your monthly bill. My Verizon insurance costs me $9/month, butI get it free because I utilize my American Express card to pay the bill. Whilethis may not seem like a whole bunch of money, $9/month for 30 years comes outto about $3,240 with no appreciation. Seems like a no brainer to me! Whilethere are a variety of other small benefits like that that vary from card tocard, you get the point.
Butback to the original point. It only makes sense to use a credit card if you canstick to a monthly budget. The reason credit card companies offer all thesegreat rewards is because they WANT you to overspend. That’s one of the waysthey make money – interest payments on carried balances. If you can stick to abudget, you’re the one that gets to profit from the relationship, and itrequires no extra work on your part except for sticking to a plan.
Another important point is that you focus on a credit card that will maximize your rewards. The Costco Citi Visa I mentioned above is great if you spend a significant amount of money on gas, travel, restaurants and Costco. If that doesn’t describe you, you might want to look somewhere else. For example, if you buy almost everything on Amazon (including groceries), the Amazon 5% cash back card might be the best thing for you. In a future post, Eric and I will break down some of the different credit cards and the benefits you get from them.
I have long been a strong and vocal proponent of using credit cards for exactly the reasons Patrick outlines above.
For me, the cash back reward is the main reason I use a credit card for almost every single purchase. Because my wife and I buy everything from airline travel to groceries on a credit card, we accrue between $200 and $500 per year in cash back. Keep in mind, this is money that we would have spent any way – we don’t change our purchase habits at all based on paying with plastic.
There are three ways I like to look at this money. Note: the mental perspective you take doesn’t change the amount of money you will “earn” with cash back, but depending on the item and your thought process, the three mental perspectives may help change your mindset.
1 I get between 1% and 5% off every item I buy. I think of this as a mini sale on every purchase I make. Think of it as a 1% coupon valid at every store with no expiration date. Because the “coupon” value is so low (1%), you won’t go on a shopping spree with it (like you might if you had a 20%-off coupon at a department store), but it is still a valid discount.
2 I have our cash back auto-redeemed to our credit card balance once the minimum threshold is met. Because of this, my credit card bill is constantly reduced by $25 to $50 per month. This mindset supposed that you paid full price for the items (ignore the 1% coupon example above), but rather your credit card company reduces your balance $25 per month out of the goodness of their hearts! (Not true – but again, just another mindset to apply).
3 I receive a $200-$500 “check” each year for no reason. While the money flows into my account slowly over the course of the year, this mental perspective gives you one “free” big ticket item per year. Recently my wife and I purchased a new computer. Using this mindset, the computer was basically free thanks to last year’s spending.
As long as any of the three mindsets above don’t dramatically change your spending habits, you are free to change the way you think about credit card cash back. For some people, the 1-5% coupon is the best way to think about it. For others, the “free” purchase works best. The key is to understand how you want to frame your cash back and deal with it in your own mind. Once you’re clear on that, you can easily see the benefits in paying with a credit card where ever you shop.
The fraud protection is another big benefit to credit cards over their cousins, debit cards. I know many people who use debit cards will claim that their bank offers the same or similar protection – and that may be true, every card is different. But I can tell you from personal experience, when I’ve had my credit card compromised, the security with the card made me feel much safer. The charges were immediately reversed, and I never paid a cent out of pocket that I didn’t spend.
In addition to the phone protection Patrick outlines, there are other significant benefits that come with credit card purchases – but note that every card carries slightly different benefits. For example, one of our cards offers an extra 12-month warranty on purchases. Say you buy a new lawnmower and the warranty expires after one season. When Spring rolls around again, you go out to start the mower and find that it isn’t starting. Assuming the issues falls under a regular warranty claim, your credit card company will step in and extend the warranty to get you a working mower. Not a bad safety net if you keep the required documentation!
While I could continue providing examples of why credit cards are the best payment method, I’ll conclude my thoughts with one final key point that wasn’t mentioned above: Credit Scores.
When you open and keep open a credit card, that line of credit shows up on your credit history. The length of time your credit lines have been open helps to improve your score as does the percentage of credit utilization. If you regularly ask your credit card company for larger lines of credit and keep the card open, you can improve your credit score without changing a thing about your spending habits.
Some people will assert that credit scores aren’t terribly important, and you shouldn’t change your personal finance habits to cater to the credit scoring agencies. While this post isn’t about credit scores, so I won’t dive too deep into the topic, it is worth noting that a good credit score has the potential to save you thousands of dollars over your lifetime. Being smart with opening/closing credit cards, using them frequently, and asking for limit increases can help boost your score without altering your life to appease the agencies. A rare positive without any sacrifices!
The bottom line is that credit cards provide significant upside provided that you can manage your spending. If you are struggling to control your spending, now may not be the right time to shift to making purchases on a credit card. The first step would be to get your spending under control and learn to live within a budget. Once you can get there – but not before – you can begin using credit cards and start reaping the benefits of free money, added benefits, and added protection!