Credit cards get a lot of negative publicity due to their astronomical interest rates and stories of individuals struggling to get out of credit card debt. However, when used correctly they can be a very powerful tool in your personal finance journey.
Free
This is often overlooked as a benefit, but credit cards are widely available and offered by just about any retailer for free (they have their reasons). Credit card billing cycle is usually 30 days. That means you could make a purchase with bank’s money and not have to pay for the purchase for 30 days. That is essentially a 30 day loan that is free of charge. Be cautious though, it has to be a responsible purchase; you must be able to pay it off with your available cash without any intent to carry a balance. What makes credit cards even better is that once the purchase appears on your bill within 30 days, you then get additional time to pay the bill before incurring interest penalties. In theory, if you made a purchase on day 1 of your billing cycle and get up to 30 days to pay off the balance, you could have up to 60 days of “free money” before incurring any interest.
Perks
Given credit card abundance and availability, it is difficult for financial institutions to differentiate their credit card over another. So they introduced benefits to the customers to sway their decision. Cashback, travel discounts, airmiles are all examples of such benefits. Depending on your habits and preferences you can choose a card whose perks best meet your needs. The average cashback perks are at 1.5%, where you get $150 back for every $10,000 spent. It does not seem like much, but it adds up over time. After all, who else is paying you to spend money that you were going to spend anyways? The perks can also be optimized to maximize returns by using different cards for different purchases. There is an entire subculture dedicated to ‘credit card hacking’. In addition to the regularly used credit cards, you can capitalize on sign-up bonuses (when needed). For example, if you are moving you will likely have an increase in expenses. Since it is a rare occurrence, signing up for a 0% interest credit card might be a good option. In most cases it gives you over a year of interest free borrowing.
Credit score
Another subtle credit card benefit is helping with your credit score. We are all just a number to financial institutions. Credit score is usually the one they look at the most. It is a metric that tells the lender whether you are credit worthy or not. It simplifies your financial life journey and assigns it a number which ends up having a substantial impact on your life. Trying to finance a car? It will cost you more with a low credit score. Trying to rent a new apartment? You could be denied, or forced to pay multiple months worth of rent prior to moving in. Want to buy a home? Again, you could be denied, or given a rate well above the market average. Bottom line, establishing and maintaining a good credit score is very impactful to your financial freedom. Credit cards can help you build your credit score when used responsibly. Use them, do not use more than 30% of your credit limit, and pay them off in time and your credit score will reach new heights.
Security
With scams happening at record rates, it would be foolish to overlook credit card security. Since you are paying for purchases using the bank’s money, you are not held responsible for any unauthorized transactions that were not made by you. When your credit card gets compromised, the worst case scenario is that your card will be locked out and you will not be able to make purchases. The bank will request you to verify your latest purchases and they will send you a new card. A debit card, on the other hand, is treated very differently. Since it is your money, not the bank’s, you may have to fight with the bank to prove that the transaction processed was not made by you. You may even have to reach out to the merchant that processed the transaction and see if it can be reversed. There are no guarantees that you will receive your money back.
Credit card trap
Credit cards are a very safe and easy way to make purchases while getting some money back in return. It is sometimes so easy that some completely forget their own limits. What’s unfortunate is that the lenders/banks, do not really monitor your limits either. The entire concept of discipline is up to you. In many cases, once you reach your credit card limit, the bank will automatically increase your limit allowing you to keep spending, making it almost worse than gambling. We all know that gambling can spiral out of control quickly. However, when gambling you can only lose what you have (let’s ignore the ‘bookies’ for a moment). Credit cards, on the other hand, make it convenient for you to spend money that you do not have because most banks will not stop your frivolous spending. They assume you know what you are doing; they assume you read all of the legal fine print they mailed you, and they assume you are responsible. If more than one of those assumptions is wrong, there is a good chance you can end up with credit card debt.
Credit cards can be a great tool in helping you achieve your financial freedom and help you protect it too. But if you do not give them the respect and discipline that they deserve then they can also ruin you. Follow these two basic rules to ensure that never happens to you:
- Do not buy anything with a credit card you cannot afford to buy in full.
- Always pay off the balance each month – do not accrue interest.