How to Use Credit Cards the Right Way
Credit cards aren’t bad… as long as you don’t abuse them
Credit is a double-edged sword. Your credit cards allow you to make large purchases, take vacations with the family and shop online. At the same time, using credit cards without a clear plan for managing the debt can put you in severe financial distress.
How to Use Credit Cards: The Basics
The Pros and Cons of Credit
With so many potential issues, it can be hard to remember that there are some upsides to using credit cards. On the other hand, it’s also vital to remember the downsides so you can protect your finances.
|You can buy needed items & cover emergency expenses||You pay more for purchases with interest added|
|There’s no need to carry cash||Additional fees can be applied to your transactions|
|It creates a record of your purchases||If you lose track of spending, you can face financial distress|
|It’s more convenient than writing checks||There is a proven increase in the risk of making purchases on impulse|
|Some cards offer rewards with great incentives||“Purchase acceleration” can make you buy more just to earn rewards|
Risky Habits When Using Credit
The following habits should be avoided if you want to avert financial distress:
- You use credit cards for daily purchases because you don’t have enough money in your budget.
- You use your cards without considering if you can pay the debt back.
- You use credit to make purchases that you know are outside of your budget, because you really want those items right then.
- You make impulse buys without thinking because your credit card is handy.
- You’re in a cycle of using one card to pay the bill on another.
- You only pay the minimum amounts due on your bills.
Choosing the Credit Cards for Your Needs
Not all credit cards are created equal. Understanding the different types of cards available can help you decide on the best card for you.
- Traditional Credit Cards. These are the most basic type of unsecured credit line available. You can purchase items up to a set credit limit and are charged a standard interest rate based on your credit score.
- Reward / Point Reward Credit Cards. These give you something back for making purchases, such as points to redeem for things like airline travel, groceries, and even special events. You earn points for purchases and once you reach a certain pint level of points, you can exchange them. These credit cards will always have higher interest rates than traditional cards!
- Cash Back Credit Cards. These give you a percentage of cash back for some or all of the purchases you make. You typically receive the money in a lump sum at the end of the year. Like rewards cards, these cards have higher interest.
- Secured Credit Cards. You can use these to build credit if you have bad credit or no credit. You put down a deposit with the creditor and however much you put into the account (minus fees) is your credit limit. You pay your bill as you would with any other credit card but, if you fail to pay, the money gets deducted out of the deposit and your credit limit is decreased.
Important Factors for Comparing Cards
When you decide to get a new credit card, make sure you consider the following factors when comparing different credit cards you’re thinking of applying to use:
- Annual percentage rate (APR): Cards can have different APR for different types of transactions. Some cards also offer an introductory APR that only applies for a certain time. Also note the penalty APR that may be applied if you pay late, miss a payment, or go over your credit limit.
- Fees / Finance charges: These include account setup and maintenance fees, charges for additional cards, as well as fees for various types of transactions.
- Payment schedule: Credit cards get paid back according to a set payment schedule that may differ from one card to the next. Some cards even require the balance to be paid in-full every month. Know how payments are set so you can factor the payments into your budget.
- Terms for rewards / cash back incentives: Don’t just assume cards with rewards or cash back are better than traditional cards. The incentives may not be worth the extra cost in interest and fees. Do some calculations to make sure you wouldn’t be better off purchasing a reward in cash and using a traditional credit card with a lower interest rate.
Staying Up-to-Date on Your Terms
Thanks to new credit laws, major changes to your terms and conditions require 30 days notice prior to the change going into effect. The following list outlines the changes a credit card company must inform you about at least 30 days prior to it taking effect:
- A change in your credit limit
- An extension of your grace period
- A decrease in any charge, not related to a change in interest rate
- A change to any optional service on that account
- A change in your interest rate as a result of a change in the reference rate
That last point can be confusing. This doesn’t mean a creditor calls to tell you when penalty APR has been applied to your account. They are only required to tell you if your APR changes because the reference rate used to calculate it changes; the reference rate is the base interest rate used to calculate APR.
Outside of that situation, you may be surprised to look at a bill and see a different APR when didn’t know a new rate would be applied. If more than one rate is listed in your contract, it’s your responsibility to know when and how different rates apply.
How to Use Credit Cards Strategically without Risking Debt Problems
If you want credit to be a key element in your financial outlook that helps instead of hurts, you must use credit in a way that promotes financial stability.
So for example, if you pull out the plastic to buy a couple of items at the mall because you’ve already spent your clothing budget for the month, that’s not a strategic use of credit. On the other hand, if you choose to put budgeted clothing purchases on a credit card because you’ll earn 5 percent cash back and then pay off the debt within the first billing cycle because the money was already allocated in your budget, then that’s smart.
With that in mind, you should really ask yourself two questions before you use a credit card:
- What benefit or advantage are you getting from putting the purchase on credit instead of paying for it in cash?
- How much more is that purchase going to cost with interest added before you finally pay it off?
These two questions can help you decide if it’s worth it to use your cards in the first place. They also help you plan what to do with the debt once it’s incurred. Ideally, credit purchases should give you an advantage without costing you in the long run.
Of course, you also want to avoid things that tend to get consumers in trouble with credit:
- Putting purchases on plastic because you’re short on cash.
- Using credit because you’re spending more than you should in a store.
- Using credit to pay bills or juggle your debts because you can’t afford all your payments in a given month.
- Spending on credit when you know you won’t be able to pay off the debt quickly before a lot of interest builds up.
Understanding interest rate grace periods
By law, every credit card has an assigned grace period set up in the billing cycle. Basically, if you start a month with a zero balance and then make purchases throughout the month, interest will only be applied if you do not pay off the balance in-full before the end of the grace period. If you pay off the balance, then no interest gets added and you’re not paying anything extra for those purchases you made. As a result, you get the full benefit of any rewards you earn.
On the other hand, if you don’t pay off your balance in-full before the grace period expires, then interest gets applied to that balance. But that’s not the worst of it – if you start a month with a balance, then the grace period doesn’t apply at all. So every purchase you make in the next month would have interest applied from Day One. Since reward credit cards tend to have high interest rates, the rewards you earn are almost always completely offset by applied interest.
With that in mind, the only way you really get the full benefit of the rewards you earn is by paying off your balance in-full every single month. Otherwise, the rewards are offset by interest added – and the longer you allow your balances to carry over, the more interest you add.
An example of offset rewards using cash back
Cash back credit cards are fairly straightforward, so for the purposes of this explanation, we’ll use a cash back credit card to explain the issue you face with rewards being offset by interest added.
Let’s say you have a credit card where you earn 5% cash back on groceries and dining out. So you use this credit card to make all of your food purchases in a given month. Give or take, you spend about $300 a month on food for your family. So you earn about $15 cash back every month.
That’s great – especially if you’re being strategic and paying off the debt on that credit card in-full every month. You earn cash back on the food you’d be purchasing anyway, then put the money you have allocated in your budget for food to paying off this credit card every month. It’s the perfect system.
… Until you let a balance carry over from one month to the next, that is.
Let’s say money starts to get tight because you have a few unexpected emergencies come up. So you start making minimum payments on the card. Now interest gets applied to your balances. Even with a relatively low rewards APR of 15% you pay more than $3 every month in interest charges. In less than five payments, you completely offset the cash back rewards you earned. And that’s only if you stop charging on the card! If you make new charges every month, you’ll offset those rewards even faster!
Other types of reward credit cards are just as bad
If you think this balancing act only applies to cash-back credit cards, think again. Consider that the cash value of each mile you earn on a travel rewards credit card is only worth about $0.10-$0.15. Even if you have one of the newer travel miles credit cards that offers 2 miles for every $1 purchased, that’s still only a cash value of $0.20-$0.30.
Meanwhile, if 15% APR gets applied you’re looking at $0.15 in added interest for every $1 transacted. Of course, it’s a little harder to do the math, but point reward cards are no different when it comes to offsetting interest. Simply put, if you’re not paying off your balances in full at the end of every month, then you’re not really getting the benefit that you think you are using a rewards credit card.
Always opt for low APR on large purchases
With all of the above in mind, part of your credit card strategy needs to be tailored to ensuring you can pay off your rewards credit cards in-full without fail every month. This maximizes the benefits of using a rewards card at all.
At the same time, if you know that you have a purchase or series of purchases that you need to make that you won’t be able to pay off in full before the end of the month, then don’t bother putting that purchase on a rewards credit card – instead opt for your credit card with the lowest APR that you have. This means less interest gets applied each billing cycle as you attempt to pay off the debt.
Key questions for strategic credit card use
By using the above information to build your credit usage strategy, you can begin to use your cards in a strategic way that supports your financial stability instead of putting it at risk. Still, you may have some questions about how to use credit to your best advantage.
The following questions are four key topics you need to know if you really want to achieve mastery over your credit cards and the debt they generate:
- How do I choose the right credit cards for me?
In this section, we help you select your credit cards strategically so you can have accounts that help you achieve your financial goals and avoid problems with debt.
- How many credit cards do I need?
You may not know it, but having a low number of credit cards can actually make it harder to achieve the credit score you want. Learn how many accounts you need to have open in order to maximize your credit score.
- How much credit card debt is too much?
Having no credit card debt is ideal for financial stability, but if you really want to maximize your credit score, you shouldn’t actually maintain zero balances on all of your accounts. We help you find the sweet spot when it comes to credit card debt.
If interest charges are eating up your rewards and draining your budget, we can help. Talk to a certified credit counselor today for a free debt evaluation to find the right solution for your needs.