The Double-Edged Sword of Credit Cards: How To Benefit
Credit cards are an effective tool for the financially disciplined. But a destructive tool for the impulsive spenders.
On the one hand, credit cards generally offer cash back or incentives, purchase protection, and additional rewards/perks on the money you would’ve spent anyways.
While on the other hand, if you aren’t financially disciplined, they can amplify bad spending habits since they make it easy to spend money you don’t actually have.
Without proper financial discipline, it’s easy to get in over your head with credit card debt. Credit cards have some of the highest interest rates out there. And if you’re not careful, you can end up in a situation where it’s hard to get out.
Pros & Cons of Credit Cards
Pros: A great tool for the financially disciplined
Cash-back incentives (usually 1-5% of purchases)
Big sign-up bonuses
Extra layer of purchase security (easy to dispute fraud transactions)
Helps build a stronger credit score if used correctly
Cons: A destructive tool for the impulsive spenders
May cause you to overspend
Racking up credit card debt is damaging to your financial future
High-interest rates if you rack up debt
Can damage your credit score if you don’t manage your spending appropriately
Should I use a credit card?
The key to using credit cards responsibly is to be aware of the potential pitfalls and to practice financial discipline. Always be mindful of your spending and pay off your balance in full each month. This will help you avoid digging yourself into a hole of high-interest consumer debt.
If you have a budget in place, actively monitor your spending, and don’t find yourself impulsively spending, a credit card can be a great tool to earn extra cash and rewards.
However, credit cards should be avoided if you find yourself overspending often. Getting an extra 2% cash back isn’t worth it if credit cards cause you to spend 20% more than you would’ve without the credit card.
Numerous studies suggest that you're likely to spend more with a credit card than with cash or a debit card. This is because it’s easier to swipe a credit card and worry about it later. Especially if you’re tight on cash. But going down that path will lead to bigger problems down the road.
So it’s best to work on controlling your spending and building a money plan before opening up a credit card. As credit cards will likely only amplify bad spending habits.
Credit card best practices
#1: Think of credit cards like debit cards (or cash) - NOT a loan
It’s best to think of credit cards like debit cards. Meaning only spending the money you have. If you have $1,000 in your checking account, the max you will want to spend using your credit card is $1,000.
The minute you start spending money you don’t have, you begin to enter dangerous territory as it’s very easy to overspend money you don’t have.
You can’t get ahead with credit card debt compounding against you at 20-30% interest rates.
#2: Pay off your credit cards in full monthly
If you use a credit card, make sure to pay it off in full every month. Doing so will allow you to avoid any interest payments on the money you spend. As a result, you’ll be able to take advantage of all the credit card benefits with none of the downside.
#3: Actively monitor your spending
It’s easy to ignore your spending habits when using credit cards. But it’s even more important to closely monitor your spending habits when using the magical swiping card.
By actively monitoring your spending, you can identify areas where you are spending more than you should and make necessary adjustments to get back on track.
If spending becomes a problem and you find out it’s because of your credit cards… you’ll know the solution to get back on track.
#4: Start by only using a credit card for fixed expenses
A good way to start using a credit card is to start by only using it for fixed expenses. Such as your insurance bill or phone bill. Any bill that costs the same every single month.
This will allow you to ease into using a credit card. Without the risk of overspending on food or other variable spending categories.
#5: Use less than 20% of your total credit limit
It is important to be mindful of not spending more than 20% of your credit card limit. Doing so can have a negative effect on your credit score.
Your credit usage ratio is calculated by dividing the amount of credit used by the amount of credit available to you among all of your credit cards.
If you use more than 20% of your credit limit, it can be a red flag to lenders and can signal that you are overstretched financially. This can also result in a decrease in your credit score.
If you pay off your credit cards in full every single month, you’ll never have to worry about this.
How many credit cards can I have?
If you’re good with managing your money, there is no limit to the number of credit cards you can open. You can open as many as you can personally handle. The best part about credit cards is taking advantage of their welcome bonus perks. Many credit cards offer cash bonuses and interest rate bonuses upon opening a new account.
I would only actively use one or two credit cards at any given time. That way, you don’t overcomplicate your personal finances too much and can better manage your credit card accounts.
If you acquire several credit cards, you can rotate through the ones you actively use at any given time. And put the ones you aren’t using aside until later.
Final Thoughts: The Magical Swiping Card
Credit cards can be an excellent tool for the financially disciplined. However, it’s important to be aware of the potential pitfalls and practice financial discipline.
The most crucial part of credit cards is paying off your balance in full each month and actively monitoring your spending.
Start by only using a credit card for fixed expenses and slowly increase the categories as you become more comfortable.
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As Always: Buy things that pay you to own them.
-Josh
Blog Post: #082
