Credit cards are everywhere. But are they friend or foe? In my world, they are friend. Let me teach you how to use credit cards wisely so you can enjoy the benefits and avoid the traps.
Credit cards rose to popularity as a mode of providing revolving credit to shoppers no longer frequenting a single department store for all their needs. Bank-based credit cards gave rising throngs of suburbanites in the ’60s the ability to purchase their needs at the newly rising ‘discount’ stores (think Target, K-Mart, WalMart) and make payments that fit nicely into their monthly budgets.
More importantly, though, changes to laws and financial innovation that allowed massive interest charges (~ 20%) and repackaging of debt as a commodity on Wall Street with this new form of credit made it lucrative for banks, investors, and retailers to coordinate and build the whole consumer credit card system.
The main message here is this- credit cards became a raging success over time because banks could make more money (off of you!) through financing, and stores could make more money (off of you!) by selling more stuff.
To make credit cards a good deal for you, you’ve got to be smarter than the system. The key is to take advantage of the good stuff, without falling prey to the costly stuff. The good news is that it is not hard to do. With sound principles to control your spending already in place (check out all the Spending Strategy posts), the card is just a convenience tool with benefits.
This post will teach you to drop the fear and use credit cards wisely.
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What's In This Post
Mindset for wise credit card use
First, let’s drop the drama over credit cards. It is true that Americans have a monumental amount of consumer debt, including credit card debt. But this is a problem that stems from a lack of solid financial literacy and not having an overall financial and spending strategy. It’s not something inherent to credit cards. Credit cards are just another financial product in an endless sea of ways to borrow money. We can blame credit cards, adjustable rate mortgages, whatever… but ultimately we must learn and choose what is the right thing to do. Financial products are designed to make investors money. Don’t be one of the cash cows they make bank off of.
So, if cards are just yet another financial product with their own list of pros and cons, how should we be using them?
Wise credit card use lies in this key principal: credit cards must be treated as a spending organizational tool, NOT as credit. Simple as that.
In other words, wise credit card users know that they should not actually be used for “credit” at all! You, my friend, have to be smarter than the system.
And so, since these are actually not a credit device at all, they are not to be used for anything you don’t have the cash for right now. They are not for a fun spending spree. They are not to splurge on a vacation you can pay off later. They are not a way to acquire anything you can’t pay for… like right now. They cannot be an emergency fund. In fact, charging on a credit card with the intent of carrying that balance you can’t pay off immediately is probably about the most expensive way to borrow money! Just don’t do it.
There are other ways to deal with emergency costs that go beyond what you can afford. Your savings, assets, insurance, loans… but not credit cards.
Instead, you can enjoy the conveniences and benefits of credit cards as a spending tool for your regular, planned, day to day spending that helps you be organized, track and limit your spending, and manage your spending in a single monthly bill. Oh, and easily rack up some free money while you’re at it.
Three financial benefits of wise credit card use
Financial cushion
A little discussed benefit of using credit cards for your usual spending is that they build in a couple of forms of financial cushion in your money management. I’m a big fan of lots of buffer money built into my money strategy (find 5 ways right here), because I think this type of being flexibly prepared for the unexpected works better in the long run than rigid micromanaging.
Credit cards act as a nice cushion for handling your total monthly spending because they essentially collect all your expenditures across a month and provide a single monthly bill for that spending. So, instead of your checking account constantly losing money in real time, you’re stacking up all your spending on this handy separate account that you can track using myriad account tracking alerts and tools.
Then, not only do you get the benefit of just one neat sum to pay all your spending for the month, but it isn’t actually due until the following month. So, there is an additional month built in for you to make any adjustments to your cash flow and accounting to pay off that month’s bill. For example, you could make returns if you went over your monthly spending cap with some misguided shopping. You may need to move money from your emergency fund into your checking account to cover anything that happened that month that was an emergency expense (e.g. broken water heater replacement). And most importantly, you can make adjustments to your current spending in response to the overall picture of the previous month.
The other way credit cards build in more cushion is through the rewards. Rewards are discussed down below, but one nice way to treat your cash back is to basically ignore them until you’re in a bind. Then you’ll have a few hundred bucks in that cash back bucket to help ease the strain on your bill some month when you need it.
Spending analysis tools
Many anti-credit card voices insist on tracking your purchases as a way to manage your money. But credit cards are one of the best ways to collect this kind of data! When you use a credit card for all your day to day spending, you essentially have a separate account with robust built-in analysis tools to evaluate all your spending across a month, year, or years. By category, merchant, amounts, all different ways. So if you truly want to track purchases to know where your money is going (something you should definitely visit once in awhile), credit cards are a great data collection and analysis instrument for doing this.
Free money
I had a professor in college that made it very clear to all of us incoming freshman that extra credit was not optional. Extra credit was points just like any other points in the course and we darn well better do all of it. In other words, never leave extra value on the table.
Credit card cash back rewards are like those extra credit questions at the end of the test. It’s money on the table that you should be getting. You should NOT spend more to get more- that is completely nonsensical. BUT when you’re spending $600 a month on groceries and $200 a month on gas, well you ought to be getting at least $15-20 in cash back each month on that spending as well. It is simply the reality of the modern world.
Maximizing credit card rewards is a topic unto itself, but for purposes of nailing basic wise credit card use, simply plan to get (on average) 2% back on all your typical mundane life spending. That 2% makes a really nice cash cushion for times when money gets tight because you can use it to pay part of your bill, reducing the strain on your cash flow for a particularly tight month.
You can also build it up for a year at a time for slush fund purposes, thereby avoiding that ‘extra’ type of spending impacting your cash flow to begin with. Think Christmas shopping, vacation spending, birthdays, etc. If you really want to be a shark, use a card that you can pull out the cash back directly, and simply put it in your savings account.
Literally free money!
New to credit cards? Tips for getting started as a smart card user
Use for one or two habitual spending types
Gas and groceries
If you’re new to plastic (or easing back in), try limiting your credit card swipes to only one or two basic types of spending. Pick something mundane to help you internalize that “card as an organizational tool” mindset. And help defend against any thoughts of the card being a magical shopping spree device (read: it is not).
Typically, one type of spending that works well is to use your new card for gas only. Only so much swiping you can do at a gas pump. Choose a card with a higher gas cash back rate and just think of it as your “gas card.” Then you’re not tempted to grab it for a late night online shopping spree (promise me you won’t!). Another good option is groceries, something predictable in the family budget. This works well while sticking to your list and shopping in smaller, simpler stores with fewer spending temptations. And there are several good cards with a higher rewards rate specifically for groceries.
Gas and groceries are also good choices for always putting on your card because they are habitual spending. And you’re trying to build the habit of making a credit card a spending organizational tool. You actually should be using it regularly. First, to build the habit of using one and paying it off over and over. And second, to capture your habitual spending into a single convenient bill where you can monitor and track your spending habits.
Habitual versus “special” spending
The idea of using your new card habitually may seem counterintuitive at first. But it is important to think about this carefully. It may feel like after getting your new credit card, you should only pull it out of your wallet for ‘special’ purchases or circ*mstances. This is reinforced by old-school advice to freeze your credit card in ice so you can’t get to it quickly. This approach would seemingly ‘limit’ your use of the card.
A responsible choice? No. I believe it is actually a dangerous path. Because it reinforces the misuse of credit spending through the craving, response, reward cycle.
It’s like the bag of chocolate chips in my baking supply cabinet. When I think of it as off limits except for for chocolate craving emergencies, I lose control, right? I’m diving in for a fistful or two most evenings by the time the kids hit their beds. But adding a scoop of chocolate chips to my mix of nuts and dried fruit every afternoon makes it normal, habitual. Under control chocolate consumption that winds up being much less than sneaking fistfuls. The credit card is not for special cravings. It’s just a handy device to organize your day to day spending. That’s it. Don’t make it more powerful or special than it really is.
Meanwhile, continue using your usual mode of spending (cash, debit) that you’re comfortable with for any other spending you do. And you will build confidence managing your credit card as a receipt collection tool on just one or two normal, everyday things. Over time, you can expand using it for all your spending. But get there gradually.
Pay it off weekly, then monthly
This idea came from a blog reader and I had to share it. When you’re learning to collect all your spending on a credit card, it could feel hard to track and control across an entire month’s billing cycle. But there’s no rule saying you can’t pay off your balance more often than that. So, practice your new process by doing your weekly spending, and then paying your balance off for the week. Start fresh the next week, pay it off at the end of the week again.
This weekly “spend & pay off” cycle helps you build the habit of using the card for habitual spending, but in small doses. Then you can go for two weeks at at time. And eventually to a whole month of your well-honed spending. Using my burn rate budget method, this approach works beautifully, helping you track & stick to your target weekly burn rate.
Mark every calendar. Do not be late.
The high interest rate on credit cards accrues on the account’s average daily balance. When you pay within the grace period (i.e. statement balance in full by the bill’s due date) you pay none of this. But the minute you’re late, you get hit with a finance charge reflective of more than that one minute.
Personally, I schedule my statement-balance-in-full payment for the due date each month and 100% avoid interest charges. But when you’re starting out, mark your calendar and plan to pay early. When your systems are well honed (stick around here and they will be!), this will become natural. When you’re new at it, however, a late payment can be a real kick in the gut. And late payments will eventually hurt your credit rating, leading to even higher interest rates and additional wasted money. Don’t let it happen.
Picking a card
Don’t trust the offers sent to you are your best option. There are a few key factors that should guide your choice. Be sure to shop around to make an advantageous choice.
Credit worthiness
I got denied when I made my first credit card application. I was a student with barely any income and no credit… but I was so offended (haha). But looking back, I was picking the wrong card! I needed to pick a student-focused card where the requirements and features were (appropriately) different.
Evaluate your credit (Credit Karmaprovides regular free access to your TransUnion and Equifax reports and scores). Research card features online using thepointsguy.com or nerdwallet.com. Pay attention to the credit range required to make sure you’re looking at an appropriate choice.
If your credit is really in the tank and you’re starting from scratch rebuilding, research secured credit cards. For these cards, you lay down a cash deposit and then can use the card up to that limit. Build your good habits, eventually you get your deposit back, and then you keep moving forward. Over time, you’ll be eligible for different types of cards, but these can get you started.
Rewards
Getting cashback for the money you’re already spending is one of the top reasons I use credit cards. It’s free money that needn’t be left on the table. Companies issuing credit cards charge merchants usually 3% of the transaction. So they make money on every swipe, even if the user never pays interest. You getting 2% cash back is just getting a slice of this pie.
The key for how to use rewards credit cards wisely, however, is to use a credit card with a rewards program tied to your usual spending. Take advantage of the perk for your normal, habitual spending. But do not use rewards as a reason to spend more to get more. Anytime you start thinking about spending more money in order to get money, a red flag should pop up. Get rewards, yes. Don’t use rewards as a justification for more spending. Getting 1-2% or even 5-6% cash back is not a good reason to buy more, it’s just a good margin to get back for nothing.
The other trap to avoid is some card programs will offer a higher redemption ‘value’ on the points you earn if you redeem them for merchandise in their online store or travel. This can be a good deal sometimes for travel you’re doing anyway.
But be careful about piddling away your free money on a bunch of random stuff that seems like a bargain. Because ultimately, did you need that cool kitchen gadget? Or did you just waste a nice cash cushion attached to your card on another thing you have to find a place for in your house? Keep the value of the cashback in the form of actual cash as much as possible. Cash that can be deposited to your bank account, be used to pay part of your bill a month when things get tight, or can be built up to exchange for gifts cards for the stores where you’re doing your Christmas shopping. Use them for something that actually makes a difference somewhere in your spending picture.
Fees
In general, I recommend only using credit cards with no annual fee. Occasionally, it may make sense to open a card with an annual fee that is waived for the first year and marking your calendar to cancel it prior to the year end. Or be earning such great rewards (like 6% back on groceries all year long) that a relatively low annual fee is more than offset. Just be sure to always verify you know if the card program you’re looking at has an annual fee. They are generally $95 and up, so not something you want to get slapped with unexpectedly!
Interest rate
Hmm… this seems like it should matter, right? But you’re never going to pay interest, right? Sooo… while it seems like bad advice, I’m not going to tell you to get too worked up about shopping around for a low credit card interest rate. “Low credit card interest rate” is basically an oxymoron. They are all too high to actually pay. Don’t. Pay. Interest. End of story. (If you were to end up in a situation of a long term debt balance on a credit card, getting it off the card onto a 0% card or paid with a type of lower interest loan would be a better bet.)
Promos: 0% interest, signup bonuses!
So here we are at interest again. If you’re a new credit card user, getting a card with a 0% interest introductory rate should not be your goal. Your goal is to use the card as an organizational tool for your normal, habitual spending. You will pay the statement balance in full, on time, if not early. The interest rate is irrelevant because you will never pay interest!
If you see a card that fits your needs that has no annual fee and offers a signup bonus, well, there you go. Free money. BUT ‘earning’ the sign up bonus requires a certain level of spending in the first few months of account opening. This is generally also not a good idea for a new credit card user. If it’s a low amount that’s below the spending you plan to do on it anyway, then fine. But a key principal you must internalize is that spending money to get money is a red flag that should always give you pause. Don’t fall for it.
For a seasoned wise credit card user, the sign-up bonuses can be a handy way to get some free cash. For instance, our family’s monthly spending cap is about $2,000. If a new card requires me to spend $5,000 within three months, that will fit well within my planned spending level. So it’s a reasonable choice to use that card for purposes of getting the promo cash back bonus. I’ve done this several times for airline tickets we needed to see family or take our honeymoon, for example.
Key Takeaways: the vow of wise credit card users
Using credit cards to organize your day to day spending can be a smart move. The added benefits of fraud protection, spending analysis tools, cashback rewards and more only sweeten the deal.
Internalize these tenants to use your credit card wisely, to unlock all the benefits while leaving behind the problems and pain.
- I do not pay interest, I do not pay interest, I do not pay interest
- My card is a organizational tool, not a “buy now, pay later” credit device
- I only charge purchases for which I have the cash to cover right now
- Rewards are a bonus for my usual, planned spending, not a reason to spend more
- What’s a minimum payment? I pay my bill in full, every time, on time (if not early), no exceptions
