Wealth Building 101 – Debt (Part 2)

Credit cards are the root of all evil in personal finance, right? Well, that depends. There are differing views on use of credit cards, but my personal view is that it depends on how you use the credit card and how disciplined you are with your finances. Credit cards can be a useful convenience that can help you manage your cash flow better and even give you a little cash back, or they can be your worst nightmare and your vehicle to financial disaster. It all depends on you.


A couple of rules of thumb for using credit cards properly: First, never buy something on a credit card that you don’t already have the available cash to pay for. Second, never, ever maintain a balance on a credit card (which is easy if you apply the first rule at the time of purchase).


Also, remember that not all credit cards are created equal. You want to shop around for the best possible deal when looking for a credit card. If you use the two rules I mention above, the interest rate is not a major consideration although I wouldn’t ignore it altogether just in case you get in a bind on month and find yourself having to carry a balance, but if you can stick to the two rules it doesn’t have to be the primary consideration.


What I personally look for in a credit card is one that has no annual fee and has some sort of perks program. The one I use has a cash back rewards program where I get a certain percentage of my purchases back in cash at the end of the year. It’s tiered based on the cumulative amount of purchases over a year, but usually averages out to slightly over 1% overall. When I was traveling for my job I put everything on my credit card that I didn’t absolutely have to put on the corporate credit card and I was religious about getting my expense reports in right after a trip. At any given time I could have as much as a couple of thousand dollars sitting in the bank from reimbursements that I didn’t have to pay on my credit card for 30 days or so. That cash was earning interest while it was waiting to pay the bill – again, taking care of the pennies!  I also received the cash back at the end of the year and sometimes got as much as $1,000 just around Christmas time. That said, I want to reinforce that this practice takes a tremendous amount of organization and discipline. If you don’t have that, I recommend against credit cards and suggest that you use debit cards instead. I also want to reiterate the theme of using them as a tool, not an extension of your income.


Sometimes the question comes up as to how credit cards can give cash back on purchases. This is due to two things. First, most credit cards charge a service charge for your purchase to the merchants who accept them. Perks programs are usually funded out of a portion of that service charge. Second, (surprise!) not everyone pays off their balance every month and the hope of the credit card company is that eventually you will get in over your head and wind up being one of those people. Live to prove them wrong!

Interestingly enough, the credit industry looks at people who pay their balances off in full every month as “mooches”. Well, I wear that title as a badge of honor. After all, it’s my hard earned money we’re talking about. One caveat here: recent legislation passed has made it harder for the credit industry to “prey” upon irresponsible people who don’t pay their bills. This has a cascading effect on those of us who use credit wisely. Credit card companies and financial institutions that offer consumer loans are now starting to charge annual fees even for those with pristine credit. Be sure to review the conditions of your credit card and read the update (required by law) that your credit card company sends to you on those conditions.

Assignment: Take a look at your credit cards. Are you paying them off monthly? Do you have multiple credit cards? If so, and if you are carrying balances on them does one have a higher interest rate than the other? If so, think about whether it might make sense to consolidate. Caution: check the conditions of a balance transfer carefully before you think about transferring balances though – many companies charge a transfer fee!