Credit isn’t bad; the misuse of credit is bad. I wanted to start off by saying this, because some of you who are reading may be wondering why I am writing a post that sounds like I may be encouraging the use of credit cards. Some conventional financial advice encourages people to avoid credit because it can lead to overspending and ultimately financial hardship. A few weeks ago I shared information on building your credit, and this week I want to share how using credit cards can actually be a good part of your financial strategy. However, although credit cards should be used with caution and handled with the utmost care, it also can be an effective part of your financial strategy. The key is having the right credit card and using the right strategy.
How credit cards can be an effective part of your strategy
A couple of years ago I read a book by Ramit Sethi, I Will Teach You to Be Rich, and the author talked about the benefits of using rewards credit cards to get paid for the spending that you would normally do. I thought that was very interesting advice. I knew that I tend to be an impulse spender, so I decided not to use it, but I see the value in it. In fact, a friend of mine successfully does it, and one of my mentors teaches this method as a way to manage your business finances and earn benefits. They advise to pay your bills and monthly spending on your credit card, earn rewards, and pay it off monthly. The reason why this is effective is you are able to earn cash back, travel rewards, gift cards, and other benefits for the spending that you normally do.
However, although I think this is a sound financial strategy, as I mentioned earlier, I do not use this method because I understand what type of spender I am. I tend to impulse spend, and putting all of my bills and expenses on a rewards card is too tempting for me to find an excuse to not pay it in full every month, carry a balance and ultimately earn interest. Therefore, I had to integrate stopgaps within my financial plan to prevent me from overspending. I do have a rewards card and use my rewards credit card to get gas (to avoid using my debit card at the pump to minimize fraud) and I use my rewards card at places where I know that the rewards percentage is higher and then after I buy, I immediately pay off that purchase. That’s the thing about creating a financial plan. You must understand how you spend, where your spending triggers are, and your weaknesses and develop a plan for that.
The key is that if you decide to use this rewards card strategy as a part of your financial plan, then you cannot spend more than you are currently spending or what your budget calls for. However, according to the survey by US News & World Report 14% of people report spending more money to earn rewards and 20% of people don’t know if they are spending more. This means that 34% of people could actually be hurting their financial health in order to earn rewards. Think about it from this perspective. When you go into a store because of a sale, do you find yourself buying more or less than you would if there wasn’t a sale? For example, in the past, I ended up spending more because I didn’t want to pass up a bargain. The same logic can be true for rewards credit cards. If you think you are getting money back, then there is a temptation to spend more.
We will discuss more considerations for a rewards credit card in this post.
Choosing a rewards card
If you are going to apply for a credit card, then I think that the best credit cards to have are rewards cards, because you will be getting a kickback on your spending. If you choose to apply for a card, then there are a few things to do before you decide on a card.
- Research the rewards program. According to the US News & World Report study, only 46% of people surveyed researched their rewards card before they signed up. This is important because, in order to choose the right credit card, you must understand your buying habits. You need to evaluate where you shop to see if you can benefit from the rewards that are offered, whether you can maximize your earning potential based on your current spending,how you earn credit card rewards, how you redeem credit card rewards, and the fee structure of the card. For example, if you don’t travel very often, it may not be helpful to get a travel rewards card. In your case, a general cash back card may be better.
- Understand the fee structure. Before you sign up for a card, you must understand if there are annual fees and other fees that could erode the benefits of the rewards. For example, if the reward card has an annual fee of $100, then whatever benefits you earn must first exceed $100 in order for the card to make sense.
- Understand when your points or rewards expire. This is key because if you don’t understand when the rewards expire then you risk not maximizing the full benefits of the card.
- Know the APR (interest rate). Similar to the understanding the fees, you must understand how much the card is going to cost you. Rewards cards notoriously have high-interest rates, therefore, use the same rigor that you would apply for a regular credit card that you would a rewards card. Even if you don’t plan to carry a balance, you still should shop around for a card with a low-interest rate in case you ever got into a situation where you were unable to pay the balance in full.
- Understand the purchase terms. For example, when I purchased my computer, I used a store credit card that allowed me to pay 0% interest for a fixed period of time and earn additional benefits. However, the fine print on the card said that if I didn’t pay it off with a certain period of time then I would incur interest on 100% of the original balance. Therefore, if you enroll in a rewards program that suspends interest rates for a period of time, understand when that bill needs to be repaid, and adjust your budget accordingly to ensure that the balance is repaid on time.
- Understand the redemption minimums. For some cards, you need to spend thousands of dollars before you even can earn credit card rewards, which can be extremely frustrating. Therefore, research how much the minimum is and how likely you are to reap the benefits. Sometimes, just being a loyalty member (for free is better). However, you must do the calculation to know if it makes sense.
How to use rewards credit cards
One theme that is woven throughout this post is that it is essential to understand your ability to pay your credit card off in full every month and to use the credit card responsibly. I continue to reinforce this because two questions that I frequently receive is:
- How do I get rid of credit card debt?
- How can I improve my credit score?” I provide a response to that question in the post, “Why Your Credit Is More Important Than You Think And How to Improve It”.
Therefore, if you can’t commit to paying it off in full then don’t use it. According to the US News & World Report Study, nearly 20% of survey respondents report carrying a balance on their rewards card. This is dangerous because the interest paid on the purchases is likely to eliminate any benefits for the rewards.
Although rewards credit cards have amazing potential in a financial plan, the biggest risks are:
- Thinking of spending as “free money.” One of the issues that I had in the past with credit cards was viewing them as “free money.” Instead of looking at how much I was spending at the moment, I looked at the amount of the monthly the minimum payment. This led to overspending, carrying a balance, and paying way more in interest than the benefits that I was earning in rewards.
- Spending to get a benefit. Although you will earn rewards on your purchases, you must ask yourself if your spending level makes sense to earn the rewards. For example, if you have a rewards card where you earn 1% back on your purchases, does it make sense to spend $500 in unplanned spending to get $5 back in rewards? On the other hand, if you were already planning to spend a budgeted $500 in spending then the $5 is a nice added bonus.
Using a rewards credit card can really provide some extra bonuses to your planned spending. However, regardless of whether a credit card has rewards associated or not, a credit card is a credit card. If you do not have the discipline to pay your credit card in full every month or pay on time, then a rewards credit card may not be for you. Also, if you are looking to increase your credit score, then you must also factor that into your decision to take out a credit card. If you decide to move forward with enrolling in a rewards credit card program, I recommend that you check out the Rewards Credit Card study conducted by US News & World Report. This study has great recommendations for how to choose the best card for your buying habits and the key things to look at before you pick a program.
I hope that this post and the US News & World Report help you to decide whether a rewards card is right for you and if so, which card is the best one.
If you want more tips and resources, then check out this FREE grocery reduction challenge to help you to cut your grocery and takeout bill so you can have more money for the things you love! Click here to join the challenge!
Aisha Taylor is a single mom of twins, personal financial coach, work from home entrepreneur, and #1 Amazon Best Selling Author of the book “5+5 FNPhenomenal Ways to Save $100 This Week Without Killing Your Lifestyle.” Aisha has been featured in ESSENCE, Jet Magazine, and Black Enterprise. She is also the Founder of FNPhenomenal (Frugal –n- Phenomenal), a movement designed to help single moms create a vision for their lives, craft a financial strategy to support that vision, and show them that phenomenal living is possible. It’s time for you to be Financially Phenomenal!