Wise Money Decisions

The IRS has a page describing the benefits of paying your taxes by credit card.  They tout the:

• Convenience,
• Security,
• Proof of payment, and
• Ability to earn cash, miles, or other rewards if you have a rewards card.

Paying your federal taxes by credit card comes with a price  -  2.49% to be exact.  It’s called a “convenience fee” although I don’t find the fee to be convenient.  The card issuer charges the fee because by law the issuer is not allowed to charge the IRS a fee.  

I usually jump at the chance when I learn of an opportunity to pay one of my regular bills by credit card because my card pays 1.5% cash back.  However, when there is a convenience fee you need to consider the numbers.

If You’re Getting a Refund, You’re Also Getting an Assignment

Before we look at credit cards, first I want to talk to those of you that don’t owe taxes.  If you are employed and you don’t owe taxes on your 2007 tax return, your employer is over-withholding from your paycheck.  If you are self-employed and you don’t owe taxes, you are over-paying your estimated taxes.

If your refund is big, say more than $1,000, I’m giving you the assignment to learn about withholding and adjust the amount withheld from your paycheck (if you’re employed) or the amount of your estimated taxes (if you’re self-employed) so that you won’t receive a refund next year.  No matter how hard I rack my brain I just can’t think of a good reason to give Uncle Sam an interest-free loan. 

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Yesterday I discussed the financial benefits of using credit cards.  Today I’ll cover the non-financial benefits.  I’ll discuss why some people don’t use credit cards despite all the benefits when used properly.  Finally I’ll discuss the possibility that credit cards raise consumer prices.   

Non-Financial Benefits

Let’s see, credit cards give you cash savings of over $1,000 per year, plus much bigger savings from lower interest rates on mortgages and car loans.  Do you need any other benefits? 

How about convenience!

Years ago I carried a blank check in my wallet just in case a place didn’t take credit cards.  After I used it I would forget to replace it.  It was a hassle to try to remember to replenish it each time. 

I never carry checks anymore.  It’s too much of a hassle.  Besides, anyplace I can afford takes credit cards anyway.

I never have to carry cash.  I don’t have to scramble looking through dresser drawers and cabinets to find cash before I leave the house. 

If my wallet is stolen, I’d much rather lose credit cards than cash or check.  I can cancel my credit cards quickly to minimize any losses.  But if I lose cash, it’s gone.  If I lose a check, my bank account number is vulnerable.  It is hard to recover money from a compromised bank account.

Think of all the convenience products you buy.  Dishwashers, washing machines, and GPS make life more convenient.  They also cost money. 

Credit cards, on the other hand, make life more convenient and they don’t cost a thing if used properly.  They save you money.  It’s not often you get a convenience product that saves you money.

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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!

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