What you need to know about Credit Cards

If you ask around, you’re bound to come across someone who talks about how dangerous credit cards are, or how they’ve cut up all their credit cards.  For the most part, this comes from a misunderstanding of how credit cards work and how one should or shouldn’t use them.  Here’s what you need to know about credit cards so that instead of hurting you, your credit cards work for you (getting you free cash)!

Here’s what you need to know about credit cards so that instead of hurting you, your credit cards work for you (getting you free cash)!

How do credit cards work?

When you use a credit card to pay for anything, technically it isn’t you paying for it in that instant.  When the payment at the point-of-sale goes through, it’s your bank or credit card issuer that pays the merchant or retailer.  You’re really loaning money from the bank up until the end of a statement period.  Then, the bank issues you a statement adding up everything that you’ve purchased using the credit card and you’re required to pay the bank back by the due date.

There are basically two ways that using a credit card can spiral out of control.  The first is overspending.  When you’re using cash or debit, your money leaving your account or wallet after every expense.  If you’re using cash, you literally cannot spend more than you have.  The same holds true for a debit card (unless you have overdraft).  With a credit card though, your only limit is your credit limit.  (To make thing’s worse, some credit card allow you to go over the credit limit, only to charge you a fee for going over the limit.) . It could be that your credit limit is lower than the cash you have on hand to pay it off.  If it’s the opposite situation (your credit limit is higher than the amount of cash you have on hand to pay the bank back), then you’ll be stuck carrying a balance on paying interest.

The second way using a credit card can cost you a lot, is if you don’t pay your bill on time.  Whether you’re carrying a balance because you’ve unintentionally forgotten or because you’ve overspent more than you meant to, you end up paying interest.

Missing a payment once or overspending in one month isn’t going to make or break you as long as you can pay the entire balance in the very next month.  The slippery slope that it is imperative to avoid, is overspending on a luxury item that you really couldn’t afford, that then takes multiple months to pay off.  It can cost you a lot in interest when you’re carrying a balance over multiple months or even years because you end up paying interest on the part of the luxury item you weren’t able to pay, plus interest on the regular expenses you’re incurring while you’re paying it off, plus interest on the interest.  It’s a slippery slope!

Keep in mind that credit card companies and banks actually rely on you overspending or not paying your balance in full.  That’s how they make their money.

With that in mind, why would you ever consider using a credit card? 

Because there are incentives, and if you play your cards right (pun intended), it literally pays to use a credit card.  When used at their best, credit cards can provide surplus value to users by avoiding fees, earning rewards, providing other benefits on money you’d be spending anyway.  Credit card rewards can range from a vacation, merchandise, free groceries or cashback.  There’s a small selection of credit cards that can help you avoid paying foreign currency conversion fees.  While some credit cards include extra perks like travel insurance, airport lounge access, rental car discounts, or roadside assistance.

If you play your cards right, it literally pays to use a credit card. 

 

How do I make the most out of credit cards?

Simply being aware of how credit cards work is the important part.  Credit cards used as a source of credit can be quite expensive and dangerous. Credit cards used as a transactional tool, that is, as a means for paying for goods and services with money you already have, can provide extra value for you. Credit cards can get you More Bang for Your Buck.

Credit cards used as a source of credit can be quite expensive and dangerous. Credit cards used as a transactional tool can provide extra value for you.

At the end of the day, credit cards are tools. Think about a car, or a lighter. Depending on how they are used, they can be an effective tool for getting around or starting a campfire or fireplace. Used irresponsibly, they can be quite dangerous!

There are two keys to getting more out of credit cards without letting them cost you.  The first is to never ever carry a balance. In other words, always pay off the entire balance every month. The second is to not let having a credit card change your spending behavior. Don’t let yourself be tempted to buy something on a credit card that you wouldn’t buy if you were paying with cash or using a debit card.

There are two keys to getting more out of credit cards without letting them cost you.  Never ever carry a balance and do not let having a credit card change your spending behavior.

One trick you can use to keep yourself in control (don’t let the tail wag the dog) or to stay on top of your spending, is, on the way out of the store, transfer the exact total on your receipt from your chequing account to your credit card. Your money is gone from the chequing account so you see exactly how much you have, and you never owe anything at the end of the statement period.  The convenience of smartphone apps makes this easy.  You don’t have to wait until you can get to a computer.

One thing to know is that some credit cards are completely free, while others have an annual fee.  Though, the credit cards with the annual fees tend to have far more perks and benefits than the free credit cards, that tend to make it far easier to recoup the cost of the annual fee.  That being said, the catch to any of these credit cards is your own self-discipline.  You just have to make sure you’re only spending what you can afford.

If I don’t overspend, what kind of rewards or value can I expect?

How much do you spend in a month on gas, groceries, meals out at restaurants, coffee, your Netflix subscription, internet and cell phone bills, shopping, etc.?  Using round numbers for the sake of simple math, let’s assume you’re spending $500 a month on these items. That works out to annual spending of $6,000. With 1% cashback in rewards (which is pretty standard on a no annual fee credit card), you could be earning an extra $60 every year. Without an annual fee on the credit card, there is no catch. You’d have an extra $60 to spend, save, donate, give or do whatever you’d like with, for doing nothing except for using your credit card (and being punctual with your bill payments) instead of cash or debit.

I would describe this as a basic level of credit card use for an individual, with a basic level of rewards.  If you have a family, your regular spending is almost assuredly closer to $2,000 a month than it is to $500.  The more you spend, the more it’s worth it for you to use a credit card.  When spending $2,000 a month on a basic no-fee 1% cashback credit card, you are leaving closer to $240 on the table in rewards.

When spending $2,000 a month on a basic no-fee 1% cashback credit card, you are leaving closer to $240 on the table in rewards.

Further, the more you optimize it, the more you can earn in rewards. (My presumption is that you remain disciplined with your spending and budgeting; that you don’t spend more because you have a credit card).  Typically, I spend less than $2000 a month on my credit card, but you can read about how I use multiple credit cards targetting specific rewards and loyalty programs to generate hundreds of dollars worth of rewards and savings each year.

 

 

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