By Scott Keegan, Chief Operating Officer/Associate Wealth Advisor
I recently talked to a couple that was trying to work their way out of some credit card debt. They described how they had many different cards with certain cards to earn rewards for certain types of purchases (gas, hotels, grocery stores, etc.). The mix of many different cards made for a confusing web of payment dates, minimum payments, and card balances.
They had good intentions of trying to earn rewards for purchases they were going to make anyway but ended up digging themselves into a financial hole out of which they now need to dig. Unfortunately, this is all too common for many Americans. According to Lending Tree, 56% of all active credit card accounts carried an active balance in the third quarter of 2022 with an average balance of $7,279.
While credit cards can be a very slippery slope, there are some tips and tricks that can be used when dealing with credit cards.
- It’s not an emergency fund.
By far the biggest piece of advice when it comes to credit cards is that they should not be used in place of an emergency fund. Everyone needs to have a funded emergency fund in an interest-bearing account (traditional savings, high-yield savings, money market, etc.). The lack of an emergency fund is often one of the biggest traps people fall into with credit cards.
- Pay it off at the end of the month.
If you use a credit card, pay the balance off at the end of the month (or statement cycle). Never carry a balance from month-to-month. This is where people get into trouble with credit cards. The interest rates credit cards charge are astronomical (generally around 20%) and will eat up any rewards earned. If you can’t buy something with cash, you shouldn’t buy it with a credit card either. Any time you use a credit card and don’t pay it off before the end of the period, the bill is going to come due with interest.
- No one’s ever gotten rich off credit card points/rewards.
Credit card companies will push many different rewards and points to get customers to sign up for their cards. It can make sense to get a card that has rewards for something you may purchase frequently or in bulk. For example, if you commute far to work, getting a card that has good rewards for gas purchases may be a decent idea. However, you don’t need a specific card for every type of purchase you make.
I have never met a wealthy person whose net worth is made up of credit card rewards/points. Also, credit card companies wouldn’t be advertising so many offers if people had figured out how to game the system to beat them through earning rewards.
- Keep it simple.
Having too many credit cards is a recipe for disaster. Like the couple from earlier, having too many moving parts makes it easy to forget a payment or to track how much is currently charged on each card. If having a credit card is something you choose to do, I would recommend keeping it limited to one or two cards with rewards lined up to what you purchase the most. Once you exceed that into three cards, it gets harder to manage. Forgetting a payment and letting that interest get charged is a good way to flush your rewards down the toilet.
- Be aware of hidden fees.
I was recently purchasing flight tickets on an airline. I was offered $200 off my tickets if I signed up for a credit card through the airlines. Save $200 and earn miles, no brainer, right?! I clicked to learn more about the card and in the fine print was the $95 annual fee for cardholders. After 2 years of holding that card my $200 saving really only saved me $10. Not quite the savings it seemed. I don’t fly enough to justify getting the card to earn flight miles, so I paid the original ticket price and went on my way.
Make sure before you review the terms and conditions before getting a card so you know all the fees and what you’re paying. Also check your current credit cards and see if there’s a fee you’re paying that you may not have to if you were to switch cards.
- Opening new cards may impact your credit score.
Your credit score is made up of multiple different aspects including hard inquiries and the average age of credit. When you apply to open a new card, the credit card company usually runs a credit report (a hard inquiry) to see if they should accept you as a cardholder. The more hard inquiries you have, the more it potentially drags down your credit score because it looks like you are applying for a lot of credit.
The average age of credit is the average length of time all your open lines of credit (mortgage, car loans, credit cards, etc.) have been open. A higher average age of credit will typically result in a higher credit score. Therefore, opening new credit cards will bring that average age of all your credit down and might bring down your overall credit score.
Credit cards can be a tricky financial tool to navigate. They can be managed responsibly but they can also get people into trouble quickly. If you have struggled with credit cards in the past or are currently in an unhealthy relationship with credit, there are ways to dig out of the credit card hole, but it does take hard work. We would love to help in any way we can. Please reach out so we can help get you on track towards financial freedom.
