Credit cards have become an essential element in our daily lives and it’s hard to visualise a life without them. They are however, a two – faced tool having a useful “good” side and a stealthy “dark” side.
As with anything that has a dangerous element to it, having knowledge of what that danger is can save us a world of pain.
The good side of Credit cards
Credit cards are undoubtedly convenient as they eliminate the need to carry physical cash. No queues at the bank, no offline ATM’s and no germ filled dirty money!
And that’s not all!
Record of transactions
As I’m a bit of an excel nerd I love downloading my credit card statement and tracking my spending!
While this may not be everyone’s cup of tea, it gives me a good idea of what I’m spending my hard earned money on and better yet it also serves to identify charge errors and fraudulent transactions for follow-up.
Have you ever had your purse stolen with a lot of cash in it ? It is almost guaranteed you will never see the cash again. Not so with a credit card and I will tell you a bit more about this in a minute.
Rewards for usage
You can get “freebies” !!
Some credit cards offer spending incentives like travel miles, cash back or vouchers to various stores. The more you spend, the more “gifts” you get back.
As mentioned earlier if you cash gets stolen it’s probably the last you will see of that money. Similarly if someone uses your debit card fraudulently you have no recourse to your bank.
Under section 75 of the Consumer Credit Act, you are covered for Credit Card purchases of items costing between £100 to £30,000 which may be damaged, fraudulent or where the supplier goes bankrupt before completing delivery.
This is the singular best use you can get out of a credit card in my opinion. Use your credit card on big purchases and pay off the balance in full at the due date. This means you essentially get free insurance against bad stuff happening on completion of your purchase.
The Bad side of credit cards
There is a dark side to credit cards and it can be a VERY dark side if unchecked and ironically arises from exactly what makes credit cards useful – their convenience and ease of use.
The buy now pay later mentality
Credit cards play into our need for instant gratification.
It requires discipline to delay our purchases and this discipline can be severely tested by the little plastic card of temptation. If you are trying to get your spending on track and reduce your debt, the best approach is to remove temptation. Stop using the credit card.
Worse yet, to support its voice of temptation it makes us feel like we have more money than we actually have. This means we are in fact literally “borrowing” from our future self without being 100% clear on what the impact is going to be on that version of us.
And you know Murphy loves to mess with us when we put ourselves in a precarious situation. It is when we are least able to deal with financial stress that Murphy will decide to teach us a lesson and send that financial stress. Don’t temp fate, don’t risk your future financial stability by getting ahead of yourself and spending what you don’t have.
For every winner there is a loser
It is not out of the kindness of their hearts that credit card companies give us spending rewards. We all know there is no free lunch, but when it comes to the “spend to earn” thinking we apply to our credit cards this gets forgotten.
If you are racking up your credit card beyond the level that you can repay it in full each month in your chase for the reward, you are on the losing side of this game. You can be sure the interest the credit card company is charging you on the unpaid balance is more than making up for the costs of your benefit,
However if you use your card wisely and only spend what you can afford to repay at the end of the credit card period, you CAN get some nice rewards without the cost, And you win.
Eye watering interest charges
If you don’t pay your credit card balance in full every month you will be charged interest on the outstanding balance.
Paying the minimum balance due is not sufficient and you will stay pay interest on what is not paid.
The credit card company is basically saying the full balance is due but it’s ok if you only pay the minimum because they get to charge you interest. And the interest rate credit card companies charge is off the charts, being a significant multiple of what you can earn on your savings account. By way of illustration consider that at the end of 2020 the average interest rate on a savings account in the UK is 0.65%. The average interest rate on an unpaid credit card balance is 20.65%.
The debt snowball
Albert Einstein apparently said that compound interest is the 8th wonder of the world. He who understands it earns it. He who doesn’t pays it.
Compound interest is magical. When it’s earned on your investments it’s a powerful wealth generator but when it is charged on your debt it is the most evil black magic ever.
And here’s a story about the horror of that black magic
Imagine you have a credit card balance of £1,000 being charged interest at a rate of 21%. You pay the minimum amount required at the end of each credit card period. Your £1,000 balance will take close on 19 years to pay off and will cost you a total of £2402. That is £1402 of interest!
My final thoughts on this
I love the convenience of my credit card. I love the fact that I can keep track of my spending and have the safety net of the bank to reclaim from where things go wrong in my purchases but I recognise how easy it is to simply dive in and spend on that “must have” item now, even though I know I cannot pay for it this month.
I think Elizabeth Warren, the US Senator, sounded out a good warning which I am trying to heed when she said; “treat credit cards like what they are; little plastic grenades that must be handled very carefully”.