Disclaimer: The advice provided in the Financially Fit series is general advice only. It has been prepared without taking into account your objectives, financial situation or needs.
I remember the first time I looked at my older brother as an actual adult. It wasn’t the first day he left home for college or even college graduation, but rather the first day I saw him take out a shiny blue credit card to pay for an appetizer round of saganaki in Greek town. But with great power (like buying flaming cheese) comes great responsibility (like being responsible about how much flaming cheese you buy).
Credit cards can be great – they offer wonderful perks and flexibility, but they can also cause some not-so-nice consequences if you are unaware of what you are doing (namely: debt). So I asked my friend Nick to help give his best tips and answer some questions about these magical plastic cards. Nick is a CPA, MBA and level 3 CFA candidate (keep your fingers crossed, everyone). He’s also a self-proclaimed credit card guru, or as I like to call him, a total finance nerd. He’s also funny (sometimes).
Q: What are the perks to using a credit card as opposed to cash/checks/my debit card?
For me, it really comes down to two words: Rewards & Flexibility.
Rewards – Credit card companies are constantly fighting to attract new customers. This means they must offer considerable rewards to get your attention. It’s just like when your grandma got a free toaster for opening up a checking account at her local bank (this actually used to happen). Rewards can be simple or complex and very broad or quite specific. Knowing how and when to use these to your advantage can greatly reduce your total daily expenses.
WARNING: Do not let the allure of rewards cause you to change your normal spending habits! Falling for this trick is what allows credit card companies to pay for these rewards programs, but I know you will be too smart for this.
Flexibility – Arguably the greatest reward that all credit cards offer is time. Based on normal billing cycles, the lag between making a purchase and the cash leaving your bank account is 30 days. This provides an amazing amount of flexibility. Let’s say I injure myself while pulling off a super gnarly 360 dunk on my fisher price basketball hoop and have $2,000 in out-of-pocket medical expenses. Paying with cash or my debit card may seriously deplete my bank account and put me in a tough situation. By putting this on my credit card, I now have 30 days, and most likely two paychecks, to ensure I have the necessary funds.
WARNING: This creates the opportunity apocalyptic scenario of spending more money than you actually have. This is how credit card companies operate and eat into your hard-earned savings. In 2014, 34% of households carried credit card debt from month to month. Repeat after me…”I will always pay my credit card in full and not carry a balance.” If you’ve bounced a check or overdrawn your account more than once in the past two years, focus on tracking your spending and ensure you can handle the risk of using credit cards on a daily basis.
Q: What should I be looking for when I’m getting a new credit card?
There are three main metrics I look at when evaluating a card: 1) Reward details 2) Annual Fee 3) Interest rate.
Now we have just established that you will NEVER carry a balance, so hopefully the interest rate is never a determining factor for you.
Rewards programs can be tricky at times and it’s important to make sure you fully grasp any restrictions or extra opportunities the card offers (this means putting on your spectacles to read the fine print).
Many of the cards offering top-tier rewards may also carry an annual fee. You will need to assess whether the rewards are still beneficial after factoring in this fee.
Q: When should I be paying off my credit card and how much of the balance should I pay off?
In order to maximize your flexibility, you should never pay your credit card bill before the due date. Many credit card companies will try to trick you into paying earlier than necessary. I always schedule my payments for the final due date and not a day before. If you’re paranoid that solar flares may cause a payment to get delayed, you can opt to pay a day early.
I promise this is the last time I yell…but ALWAYS PAY YOUR ENTIRE BALANCE. I won’t bore you with the math, but if you only made minimum payments, that $300 iPhone will end up costing you $375 and lower your credit score to boot.
Q: How many credit cards should I get/have and how do they affect my credit score?
You should only get a credit card if it offers the ability to lower the cost of something you are already buying. This either means new rewards in a specific category or better overall rewards than the card you are currently using. Getting additional cards just for their signup bonus is not advised. I currently have five credit cards but only three that I use (Blue Cash Preferred for groceries, a card for restaurants and my Starwood card for all other purchases). The remaining two are older cards that I have replaced with better rewards but keep open for a few reasons (see below).
There are many factors in determining your credit score. We won’t touch on all of them, but I will focus on a few related to credit cards that you can easily control.
Credit length – The longer your credit history the better. I still have my first credit card account open and buy one small item a year to keep showing activity. This long history of on-time payments helps to increase my credit score.
New credit – Opening up several credit cards at once is a sign of somebody possibly desperate for cash and that lowers you credit score. Even if you find two great cards to open (see above), do not open them at the same time and wait several months between new accounts.
Credit Usage – This represents the average amount of your total credit line you are using. Having more than one credit card may assist in increasing your score here. For example: if I spend an average of $1,000/month on my credit card and my credit limit is $5,000, I am using 20% (1,000/5,000) of my available credit. Now, if I have a second credit card with the same limit and I spread my spending over the two, I’m now only using 10% of my available credit ($1,000/$10,000). Even if you only want to have one credit card, many companies allow you ask for credit limit increases, with no negative effects if you are declined. I usually apply for an increase a year after opening a card and every annual period afterwards. This allows me to lower my credit usage and therefore increase my credit score.
Q: Any best practices for using a credit card / tracking spending?
As you can probably guess by now, I’m pretty intense about this and I track all of my spending using Mint. I know several people are leery of this service and many of its competitors (such as Learnvest) given the access you have to grant them to your accounts. I have found that the time and work required to maintain detailed budgets is often too exhausting for people to do on their own.
As I’ve stated many times, credit cards are only for those who are responsible enough to manage their spending and make payments on time. Ensure you are up to the task before you jump into the world of rewards and bonuses.