Every so often I see someone give the advice that you should shred your credit cards and use cash or debit cards instead. This may be good advice for people who have a dysfunctional relationship with consumer debt. It is not good advice for most people.
There are four big advantages of using credit cards. The first three advantages put more money in your pocket. The fourth advantage is one of convenience. Today I’ll cover the first three from smallest to largest. Tomorrow I’ll cover the fourth advantage and address a few miscellaneous points.
Defer Payments
First, credit cards allow you to defer payments.
When you buy groceries at the supermarket with a debit card or cash, you spend the money immediately.
On the other hand, when you use a credit card you typically keep control of the money for about 30 days before you finally spend it. Here’s how I calculate 30 days:
It takes a day or two for the purchase to post to your account.
On average it takes a couple weeks to receive the bill from your credit card company. Half your purchases occur during the first half of your statement period, while the other half of your purchases occur during the second half of your statement period. If you average out the timing of all the purchases, the “average” purchase occurs right in the middle of your statement period. In other words, you don’t get the statement until 15 days after the “average” purchase.
After you receive your bill, you have a few weeks of grace period before you finally make the payment. You don’t want to wait until the last minute to pay your bill if you send in a paper check or use your bank’s online billpay. But if you pay on the credit card website you can wait to the last minute if you want.
Add it all up and you have about 30 days of deferral.
Why is it nice to keep your money an extra 30 days? Time value of money of course. If you invest the money for 30 days before you pay your bill, you get to keep the earnings. If you pay with cash or debit card, the bank keeps the earnings.
You might be thinking, “Big deal! It’s just 30 days of interest. It can’t be that much.” Whether it’s “much or not much” depends on your perspective. It’s not a big deal for a single month. But it gets to be a bigger deal when added up month after month after month.
Let’s do the numbers:
Suppose you spend $2,500 per month on credit cards. You float the $2,500 in a 5% money market account for 30 days until you pay the bill. You make an extra $10.42 per month. Over the course of a year, that’s an extra $125. Granted, it’s not a huge amount. But you didn’t have to do anything for it. No reason to leave money on the table.
If you invest the float money at a higher rate, you make even more of course!
Rewards
Use credit cards that give you rewards. Some cards pay you in cash, airline miles, points, or other ways. I have used cash rewards cards. I have never used an airline miles or other type of reward card.
Different cards have different reward levels for different types of purchases. If you want to optimize your rewards, you need to have more than one card and you need to use each card for the right purchases. For example, I have the American Express Blue Cash card that pays 1.5% on most purchases, and 5% on groceries, gas, and drugstores. I have a different American Express card that pays 3% on restaurants and 2% on travel (airline tickets, rental cars, hotels, cruises, etc.).
The Blue Cash card has a lower tier for the first $6,500 in spending each year. While I’m in the lower tier at the start of the year, it only pays 0.5% on most purchases and 1% on groceries, gas, and drugstores. While I’m in the lower tier I use Blue Cash only for “other” purchases, and I use a different card without a tier structure that pays 5% on groceries, gas, and drugstores. This other 5% card has an annual cap on what I can earn. So once I hit the higher tier on Blue Cash through the “other” purchases, I focus on Blue Cash for all purchases. I take the other card out of my wallet for the rest of the year.
I have to remember to use the right card when I buy different things. After a while it becomes automatic.
If you don’t want to bother with multiple credit cards, use the Blue Cash. It’s the best card right now.
Let’s do the numbers for the multiple card, optimized approach:
Let’s suppose you spend $2,500 on your cards each month. Let’s suppose that $1,000 is gas and groceries, and $200 is restaurants.
Your monthly reward is $70. That’s $840 per year, with hardly any work on your part! The only cost is a little organization and a little time each month to pay an extra credit card bill.
Building a Credit Score
There is another benefit of using credit cards that doesn’t help you in the short term, but helps you immensely in the long term. Before you have a mortgage or car loan, credit cards are the primary tool for establishing a good credit score.
I got my first credit card in college. I paid off my balance each and every month. I never carried a balance and never paid late. IMPORTANT: TO BUILD A GOOD CREDIT SCORE, YOU NEED TO PAY OFF YOUR CARD EVERY MONTH!
When I needed credit to buy a car, I had a solid credit history and a good credit score. It probably saved me hundreds or even thousands over the life of my car loan.
When I needed to rent an apartment, the landlord went out of her way to make the place sound appealing. She knew I had a good credit score and I would pay the rent.
When I took out a mortgage I was lucky enough to have a credit score in the top tier. I got the best rate available.
The numbers on my mortgage:
If I had a credit score one tier lower, I would pay $65,000 more in interest payments over 30 years. Realistically I’m not going to live here for 30 years. But the savings are significant even over 3-5 years. Plus, I’ll realize similar savings when I buy the next place, and the one after that, and the one after that.
Even without the first two advantages discussed above, credit cards would be worth using for the sole purpose of building your credit score.
Stay Tuned
Tomorrow I’ll cover the fourth advantage and discuss how credit cards raise consumer prices.
Part 2 of this article here.
[…] Why You Should Use Credit Cards (Part 1 of 2) […]
Good article and I couldn’t agree more with you. Using a cash back credit card is by far the simplest way to earn rewards while letting your cash earn interest.
Another good Rewards card for limited use is Discover. They have a new 5% cash back category each month or quarter. This quarter they have 5% cash back on travel expenses (airline, hotels, etc). While it can be hard to remember when to use it, you can’t beat 5%.
Robert:
I have that Discover card. I believe it’s the “basic” Discover card.
It is nice to get 5% on categories that you wouldn’t get with other cards. I don’t use it much because I forget which categories are up each quarter. I usually think about it when I need to make a big purchase, like airline flights. But I believe there’s cap on how much you can get back each quarter.
In order to get the 5% you need to register with Discover each quarter. I think it’s their way of making sure your contact information stays current.
Thanks for your comment.
[…] Card By Jeff There are several good reasons to use credit cards. They save you money, they build your credit history, and they’re […]
I appreciate all the tips, they are all very practical, unfortunately not many people proud themselves for keeping control of their credit cards. I guess we need more financial education in this matter, this might be the right solution for solving the credit “crisis”.
[…] establish good credit. If you don’t have much of a credit history, begin to establish one by getting a credit […]