Credit cards, when used carefully, can play a positive role in your financial life. Using credit wisely is critical to building a solid credit history. If you need a loan or a mortgage, or you want to renegotiate a loan, a good credit rating is important and will help you negotiate the best terms. But credits cards used carelessly can send your life and finances into a tailspin.
But we all know this, right? So how do smart people with six figure incomes end up with more credit debt than they intended? Often it’s the seductive lure of credit card reward programs.
How many people do you know who put almost everything on their credit card so they can earn reward points? Maybe you do it too. Well let’s take a look at the perks and pitfalls of a rewards plan spending habit.
1. If you are using a card with rewards that are of value to you, and you are paying off your balance each month, you may be benefitting from the program.
Well that was a short list.
Unfortunately this list isn’t as short.
1. It’s easier to spend more than you intend when you use credit. This is a two-fold pitfall.
- If you overspend you may not be able to pay your balance off at the end of the month. If you are making a reward of 1 or 2 percent on your spending, but the interest is upwards of 18% your rewards evaporate.
- Even if you do pay off your balance; if you impulse spend $50.00 a month extra on your groceries, that’s $600 a year. You would have to spend $60,000 to earn a 1% cash back of $600. Wouldn’t you be better to stay on track with your spending by using cash and put that $50 in a travel account or towards something you really want?
2. Something unexpected comes up, like a major car repair or your roof leaks, and you are unable to pay off the balance in full. Life happens, but the moment you begin paying interest your rewards are a moot point.
3. Annual fees. If it costs you $100 or more for the privilege of using the credit card you may have to spend over $10,000 just to breakeven.
4. What are the rewards? A card that offers great travel perks may seem exciting, but if you don’t travel often it isn’t very relevant to your life. Whatever the promised rewards, make sure you know how much you will need to spend to earn them. It may not be worth the risk of overspending.
5. Debt has a tendency to breed debt. The moment you start carrying a balance not only do you cancel out the benefit of the rewards, you run the risk of being short each month because of credit card payments, and the possibility of turning back to the credit card to help make ends meet “just for now” becomes very tempting.
It’s all too easy to disconnect from the implications of spending when the day of reckoning is a month away, instead of immediately like it is if you use cash or debit. If you want to enjoy credit card reward perks and avoid the pitfalls, it’s vital that you use the card thoughtfully within the context of a financial plan and a system for managing cash flow.
Remember, mastery over your money is the best reward of all.