A credit card can be a notable source of savings, or a shovel that digs you into debt faster than you knew to be possible. With great power comes great responsibility – let’s make sure you end up on the responsible side of the fence. After reading this, you will be equipped with knowledge on how credit cards can benefit you, how they can cause damage, and whether or not the risk is worth the reward. Finally, we’ll touch on how to get that shovel out of your hands if you can’t stop digging.

Disclaimer

I am not a professional financial advisor. The information provided is for educational purposes only. A qualified professional should be consulted before making financial decisions. I am not responsible for any errors, omissions, or the results obtained from using information on my site. The user of this website assumes all risks associated with actions that they take.

Past performance is not indicative of future results. No particular result can be guaranteed. All investments involve risk, often including a potential loss of principal.

Credit cards at a glance

Credit cards are appealing as they’ll often offer a rewards system for all things you would “purchase regardless”. You already need what you’re buying, so why not simultaneously work towards a free trip, a discounted hotel, or put a certain percentage of the cost back in your pocket? In theory, you’re right. Optimize, and benefit. In practice, you could be right. Ensure you understand the game, as there are traps along the way that could shoot you back to the start of it, if not start you at a new game you’d need to beat just to get back to baseline.

Play the system, or get played by the system.

The objective of the credit card game is to make credit cards benefit you. These companies are businesses taking calculated risks. You can bet they know their odds. Why take any risk at all? How could credit cards work in your favor?

• Credit score improvement. Your credit score bleeds into all things finance. It will pay dividends if you work to build and maintain it.
• Discounts (cash back). Every dollar counts. A dollar saved is a dollar earned.
• Rewards. Cash back is my favorite, but we can’t overlook the aggressive travel rewards and one-time bonuses that some cards offer.
• Security. The likelihood of you having to pay for fraudulent purchases that you did not make is drastically reduced when using a credit card.

Pretty good, right? Those are your focus points for winning. How could you lose?

• Absurd interest rates. You’re not only punished through paying interest on credit cards, but you’re also ruined. A bit dramatic, but it is detrimental. Read further to understand the caliber of this issue.
• Fees. Even if you make all of your payments on time, you won’t be able to avoid the annual and foreign transaction fees of cards that charge them.
• Accessibility to debt. It’s already pretty easy to make poor decisions. You want an environment conducive to making good decisions. Think twice before enabling yourself to spend more than you have…it can sure add up quickly.
• Impact on credit score. Credit score improvement was listed as a benefit. If the card is misused, you’ll pay for that mistake in interest and pay for it again and again due to the effect it has on your credit score.

The good and the bad, summarized

The “good” has to do with the opportunity to improve credit score, cash back on all purchases, card-specific rewards, and security. The “bad” includes very high interest rates, annual and transactional fees, easy access to debt, and potential negative impacts on your credit score. I would argue that the bad far outweighs the good. The reason that I use credit cards despite this is because, with organization and knowledge, you should never experience any of the bad.

The ugly

The ugly is usually a result of a lack of knowledge or unforeseen circumstances. Credit cards are not emergency funds. If you don’t have the money to spend and you don’t need to spend money, it would be wise to stay as far away from financing as possible. The last thing you need if you don’t have money is payments owed on the money you don’t have.

Here’s a nightmare scenario that might help you gain greater respect for the possible consequences of misusing a credit card.

The average APR (annual percentage rate), or interest rate of a credit card, is 25.33%. If you were to rack up $10,000.00 in credit card debt and paid $250/month towards your balance, it would take 7 years and 3 months to pay it off. $11,724.31 would have been paid in interest. Plus, you would pay your $10,000.00 on the principal itself. It cost $21,724.31 and over 7 years to recover. This is assuming you made every payment on time. Try out this calculator for further examples.

What did that $10,000 purchase do? It took an additional $11,724.31, which limited your ability to save or invest $250 for 87 months, and it likely impacted your credit score negatively through maintaining that high level of credit utilization. Not to mention, if you miss a single payment during that period, all of those items compound negatively. That’s only the raw cost. Factoring in opportunity cost, assuming that you could instead invest $250 per month for 7 years with a conservative return of 7%, $250 per month would be nearly $27,000 after 7 years. The difference in these two scenarios is $38,724.31.

Hide the shovel

Awful news, and probably not particularly motivating to those with credit card debt already. You can make an enormous impact on your future trajectory by getting on top of existing credit card debt and eliminating tendencies that put you here in the first place. Here are a few strategies I might apply to repay high-priority debt.

1.) Eliminate excess spending wherever possible. Take money from anywhere you can to address this issue. If you’re at all familiar with Andrew Giancola, this is a “pants on fire emergency”.

2.) Look into both the snowball method and the avalanche method. The snowball method has you pay your smallest debt off first, making for quick wins that positively impact your psychological relationship to debt. The avalanche method is mathematically optimal, targeting the highest interest rate debt first.

3.) Discontinue credit card spending. Whether this will be a new set of simple rules (“I will not spend on credit until my current debt is paid”), or if you’ll need to cut the card and cancel, you cannot continue spending on credit. Stop now.

Being aware of debt is the first step to addressing and eventually getting out of it. As with many things worth doing, you’ll often be uncomfortable upfront to be substantially better off in the long run. You can pay off your debt, and the sooner you start, the sooner you’ll be debt-free. The category of high-interest debt is not one with compromises. If you are financially intentional, you are not carrying high-interest debt for long.

For those with no running credit card debt

If that last section felt like an attack, you have plenty of direction from this post already. Stop here and tackle the task at hand. If high-interest debt is not part of your life, and your track record proves that it will not be part of your future, let’s talk about how you can play the system.

Credit score made simple: By using your credit card for purchases that you are sure you can repay on time in full, your credit score will naturally skyrocket. Since my early twenties, I have had a relatively easy time hovering between 750 and 800 without any fancy tactics – use the card, be mindful of utilization, and prove reliability through transactional volume (use the card often) and credit line age (don’t switch cards unless you’ve got a great reason to). Do the basics right, and you’ll have to ask to keep your credit line small. Take the increases and stay responsible so that utilization is hard to mess up. The greater total credit you have access to on a given line, the less your utilization of the total will be, assuming you don’t increase spending at the same rate that limits are expanded.

Cash back: These numbers may not seem staggering, but “free money” is hard to come by. If you spend a total of $35,000 annually and earn 3% cash back, you’ll net a reward of $1,050. Sticking with the 3% example, every $1,000 purchase is “discounted” by $30.

Rewards: If you’re a fan of frequent travel, plane tickets, trip packages, car rentals, and hotels can be disproportionately inexpensive when applying credit card rewards. This is a benefit that varies by card, so you’ll want to reference a resource like NerdWallet and do some comparing.

Anti-fraud: The ability to freeze credit or to dispute misrepresented charges not only provides peace of mind, but it can also result in huge savings in the event of a security breach. Read the company’s terms and conditions and spend the time to set up app accessibility so that you understand these features and can access them quickly when necessary.

The verdict

Credit cards can fast-track your journey to strong credit while saving you money along the way, or they can fast-track your journey to diminished credit while costing you. Do your research, consult professionals, be your own best source of feedback, and iterate. Hopefully, this post serves as a block that fits well into your financial structure and reinforces what you’ve built so far.