Credit cards can be a huge relief, especially when you hit a rough patch, and if you’re like me your credit card is incorporated into your everyday life. Credit cards have numerous benefits, but if you’re not careful they can go from being a great financial safety net to being a source of grief really fast! So how can you make sure credit cards are never a pain?
Before I even begin, do the following descriptions pertain to you?
- I use credit cards to purchase items that I could not otherwise afford with my debit card
- I don’t pay off my credit card in full every month
If either, or both, of the preceding statements apply to you, then no, it is not a good idea to use credit cards.
Stop using credit cards, or stop using them until after you read through this.
It’s easy to think of a credit as an extension of your debit card, because if you’re anything like me, they are placed in the same location in your wallet (Yes, Canadian Millennials still use wallets because basically nowhere in Canada accepts mobile payments). The truth is, they’re not. Credit and debit cards are not the same. In fact, in accounting, debits and credits are the exact opposite!
What credit cards are, and how you should view them, is a method for procuring short-term loans. They enable the easy borrowing of money instantaneously, and in exchange, charge some of the highest interest rates on that borrowed money. Just for fun, I looked up the interest rates on two of the easiest methods to borrow money from TD Canada Trust. On a variable rate line of credit, they charge an APR (Annual Percentage Rate) of 2.7%. On one of their entry level credit cards, they charge an APR of 19.99% (To be fair to TD, you do get .75% cash back on all purchases, so, that’s neat).
Interest rates are rather meaningless without numbers to back them up. Assume that you borrow $1,000, and just don’t bother to pay it off for a year, probably because you hate my advice (I’d be a little sad about that, just being honest). For simplicities sakes, let’s just say the interest is compounded annually (Which it wouldn’t be in real life, it would be compounded more often, and you would owe more). With those assumptions, you would owe an additional $27 on the line of credit, and $199.90 on the credit card.
It’s clear under these circumstances that borrowing from a credit card, and not bothering to pay it off is a bad idea. “But Anthony”, I can hear you saying, “The average Canadian obviously wouldn’t have $1000 worth of credit debt like that!”
You would be right; the average Canadian does not hold $1000 worth of credit card debt. According to debtcanada.ca, the average Canadian holds $2627 worth of credit card debt. It’s clear that Canadians are not using credit cards correctly, which leads back to the initial question of this article, “Is it a good idea to use credit cards?”
The answer: Absolutely.
I bet you didn’t see that coming! You see, using credit cards has an incredible amount of advantages if used properly. Personally, I use credit cards for about 90-95% of my purchases, with the remainder being used for purchases that cannot otherwise be made by my credit card. While it is true the interest rate for credit cards is ludicrous, it is also true that if you do pay off your monthly statements in full, you aren’t charged interest what-so-ever.
“But Anthony”, you may be saying again, “Why not just use a debit card or cash as opposed to a credit card?” That’s a fair question. Credit cards have numerous benefits, including:
- If they are stolen, there is no direct link to your money, and you can easily cancel them
- You can receive benefits, such as cash back on some/all purchases, and reward points that can be redeemed for various items
- You can help your credit score by using credit cards effectively. In the future, you will be able to apply for loans such as mortgages, and potentially save tens of thousands of dollars on your mortgage
These benefits are all great reasons to use credit cards over debit cards or cash. The caveat being, if you don’t use your credit card effectively, these benefits are meaningless.
As a result, I have created a list of rules to abide by when using credit cards. If for any reason you don’t believe you can follow these rules, then do not use a credit card:
- Only spend as much on a credit card as you currently have in your chequing account. This is a general rule, but I follow a modified version of this rule, which is to only spend up to 20% of my chequing account at any given time.
- Always make sure that you are able to pay your credit card in full (not the minimum payment amount) prior to the statement end date.
- If you have trouble controlling spending on your credit card for any reason, do not use a credit card.
- Never withdraw cash from your credit card: This is similar to throwing money away! You get charged 2-4% of the withdrawal amount as a cash advance fee. You are also charged an ATM fee of about $5. Also, if you are unlucky you might have to pay an interest rate on this withdrawal much higher than your APR, the next day (instead of the standard 30 – 50 day interest- free period, banks usually give). Just don’t do it!
- Always pay your credit card on time
Credit cards can be an effective tool to use in your personal finances if used properly. By following the above rules, you can build your credit, and receive immediate benefits from doing so. If you do have credit card debt, and you can feasibly pay it off, then please, stop reading this and pay it off right now.
… Seriously, go pay it off. I’m waiting.
Now that you’re back: Great job! You have just made one of the best investments you could make! Want more investment advice? Stay tuned for more entries to Investment Conversations!