Using Credit Cards to Your Advantage: A Beginner’s Guide

Credit Card Spenders vs. Credit Card Haters

There seem to be two dominant attitudes regarding the use of credit cards. On one hand, there are “The Credit Card Spenders,” i.e., those who view credit cards as “easy money.” They treat credit cards as a means of extending buying power beyond earned income, usually to purchase things they want but can’t afford at the time. On the other hand, there are “The Credit Card Haters,” i.e., those who are aware of the financial danger that credit cards pose as a result of their high interest rates and fees. While The Credit Card Spender tends to charge away happily with virtually no discretion, The Credit Card Hater virtually avoids using credit cards altogether, opting instead to pay for things by cash or debit card while purchasing only what she can currently afford.

The reasoning behind The Credit Card Hater’s attitude towards credit cards might not be so obvious at first, so let’s illustrate by example just how financially imprudent credit card usage can be: Suppose Sam The Credit Card Spender receives a card with an $8,000 limit at 15% APR, which she proceeds to max out in an epic spending spree that begins the second after she activates her card and ends just before she receives her first bill. To say that Sam is a personal finance newbie would be an understatement. But she means well. In the midst of her shopping hangover, she vows not to charge a single penny more to her card. Yet, she presumes the minimum payment printed on her bill each month (the product of 2% of the remaining balance or $20, whichever is greater) is all that she owes, so she proudly mails in a check each month equal to the minimum payment. Sam is encouraged as she observes the payment drop each month. First month: $160; next month: $158.80, and so on. “These low monthly costs sure seem like a small price to pay for $8,000 worth of stuff,” she says to herself. What Sam fails to realize, however, is that the reduction in minimum payments isn’t a feature of responsible credit card loan management, but instead significantly prolongs her payback time and ends up costing her far more money than if she were to pay a fixed amount of, say, $160 each month. Here’s a comparison:

Option #1                           Make Min. Payment

Total Paid:                      $20,245.78

Total Interest:                 $12,245.78

Total Years to Pay off:       29.75

Option #2                           Pay $160/Month

Total Paid:                      $12,632

Total Interest:                 $4,632

Total Years to Pay off:       6.58

It’s obvious that it’s in Sam’s interest to pay more than the minimum balance each month. However, even if she pays a fixed rate of $160 each month, she’ll still end up paying 58% more than what the stores originally charged her. In other words, that jacket Sam thought she bought at a “bargain price” of $100 would end up costing her $158 if she followed Option #2; much better than the $253 she’d pay under Option #1, but still worse than raising her monthly payment. In other words, the more Sam pays, the more she can combat the price hike in the true cost of her credit-card bought goods. Nevertheless, carrying any balance on her credit card means she’ll pay more than the price paid at initial purchase. Hence the message of the The Credit Card Haters: voluntarily financing non-emergency expenses through credit is just plain dumb. Better to pay cash.

A Third Option: Credit Card Saving

If Credit Card Spending and Credit Card Hating were the only two options in town, the clearly superior choice would be to become a Hater. However, there’s a third option that involves using a credit card without the downsides outlined above and with some advantages over Credit Card Hating. Let’s call this third option “Credit Card Saving.” Not because it involves collecting rectangular pieces of plastic, but because it involves a change in mentality, namely, one that eschews the “buy now, pay later” attitude that the Credit Card Spender adopts and the Credit Card Hater abhors. Instead, the Credit Card Saver treats rewards offerings as a strategy to preserve one’s savings.

The Credit Card Saver recognizes that credit cards don’t have to be toxic to one’s personal finances. The downside that the Credit Card Spender experiences doesn’t result simply from having credit cards and using them, but from using them and carrying a balance. If Sam the Credit Card Spender were to become a Saver and use her cards only to pay for her monthly expenses, keep her expenses lower than her income, and pay off the total balance on her card each month in a timely manner, she’d never incur any interest or fees. As a Credit Card Saver, Sam would have the discipline to treat her credit card much like a debit card, purchasing what she needs rather than buying things she can’t currently afford. But instead of having her money withdrawn with each purchase she takes, she’d receive a bill at the end of the month totaling her expenses for that period. This has the advantage of allowing savings to compound over a greater number of days as it sits in an interest bearing checking account for a longer period of time.

However, unless Sam’s spending tens of thousands of dollars each month, the added interest she’d collect over the course of the month would likely be pretty miniscule. If the only savings advantage of using a credit card came from collecting a tiny bit of extra interest in a bank account, it might not be worth the hassle. But the real potential that credit cards offer in preserving savings comes from taking advantage of cards that have rewards perks.

Thanks to realsustainablehabits.com