Sometimes, the simplest questions are just perfect.
How do people even use credit cards without messing everything up?
A reader we’ll call Jean sent that to me at the start of a question for the reader mailbag. Afterwards, Jean offered up a pretty typical story of credit card use: relying on it for purchases, gently inflating one’s lifestyle, losing track of what’s actually going onto the card, and suddenly facing big bills.
Jean isn’t alone. In America, 38.1% of households carry some kind of credit card debt and the average credit card debt for a family carrying a balance is a whopping $16,048. That’s approximately four months of take-home pay for the average American family, and given the average interest rate of just over 15%, the average American household will be paying approximately $640 a month for the next fourteen years to get rid of that debt.
Many, many articles and books have been written about how to get rid of a mountain of credit card debt. Here’s my own guide to building a debt repayment plan, for starters.
However, not as many articles focus on using credit cards smartly and effectively to get maximum value out of them. Why? It’s much easier to simply advise people to just not use credit cards at all. After all, we can live without them – you can use your debit card for most purchases and living within your means is a lot easier if you’re just using your checking account.
This brings us right back to Jean’s question. How do people even use credit cards without messing everything up?
Many years back, I racked up quite a lot of credit card debt, and in the following years, I’ve paid it all off. I currently make most of my purchases with a credit card and I haven’t carried a balance in many years (aside from a couple mistakes due to automatic bill pay shenanigans that I should have been watching more carefully and corrected as soon as I found them). I use a credit card many times per month and I have not actively carried a balance in several years.
How do I do that? Here are the “secrets” of getting maximum value from credit cards.
First and foremost, if you think to yourself, “I can’t afford this, but I could put it on the card,” then you shouldn’t be buying that item. Credit cards are not “free money you can pay back later,” so don’t treat them like that. This is absolutely the first rule of smart credit card use. They’re not free money. Don’t think of them as free money. They are not a tool to leverage purchases you wouldn’t otherwise be able to afford. Period.
If the purchase you’re considering is an absolute need, then you’ve either made some other spending mistakes to put yourself in that position or you’re walking such a tight financial rope that you need to be considering some significant life changes outside of credit card use, such as cutting some major expenses (like moving somewhere cheaper or eliminating a car) or getting a better job or an additional one. Credit cards should not finance your lifestyle, ever. If you buy things on your card that you can’t pay out of pocket, you will wind up in a financial mess.
The challenge with credit cards is that it can be very easy to disconnect the money in your checking account from the expenses you put onto that card because the impact of that expense doesn’t show up in your checking account immediately. If you buy something with a debit card, your checking account balance goes down immediately. On the other hand, if you buy something with a credit card, you have the item and your checking account balance doesn’t change.
This creates a disconnection problem. It can give a strong sense that the item or experience that you bought with the credit card was somehow “free,” which somewhat disconnects you from the actual expense of things. At the same time, it makes a credit card bill feel very separated from the actual things you bought to incur that bill. Rather than feeling like you’re paying back Amazon for the thing they already shipped to you, it can feel like Amazon gave you that item and you’re actually paying Chase for the privilege of using a card, which can feel frustrating and meaningless. No one relishes writing a check to the bank.
Most successful credit card users figure out some way to bridge that disconnect, and there are a lot of tools for doing this.
Start with separating “needs” and “wants.” Many people stumble at this step by either not bothering at all or by not really thinking about it. The point of this is to really assess the money you spend on needs so you can see how much is actually left for wants and then base your spending going forward on that.
The trick is knowing how to separate the two. For example, most groceries probably fall under “needs,” but eating out falls under a “want.” Housing falls under a “need” unless you can obviously and easily move to somewhere cheaper, in which case part of your housing cost is a “want.” If you commute, a basic car is a “need,” but an expensive car is mostly a “want.” Netflix is a “want.” Cable television is a “want.” Soda is a “want.” Alcohol is a “want.” Unless you work from home and it’s necessary, internet is a “want.”
Why is this distinction so important? Most people really don’t recognize how much money per month they spend on “wants.” They just get used to unnecessary expenses and, in their mind, gradually begin to shift things like eating out into the “needs” category and allow their “wants” to keep inflating. When you never step back and look at how much of your monthly expenses are made up of “wants,” you never really see how rich and full your life really is.
Go through your bank statement and credit card bill for the last month and separate everything into “needs” and “wants.” One good way to do this is to use a pink highlighter for “needs” and a blue one for things that are mixed; leave “wants” blank. Go on, do this, and then come back. I’ll wait.
Got it? Good.
You probably noticed that there are a TON of things on there that are “wants” when you’re honest with yourself and many more are mixed bags. There are likely few expenses on there that are truly “needs.”
Now, spend a minute and go through all of those “wants.” Think about how much you actually spend on just adding a bit of momentary pleasure to your life. Meals eaten out. Cable. Internet. A bigger house than you need. A nice car. Alcohol. Snacks. Entertainment items. Excess clothes. Premium household items. On and on and on.
The purpose of this little experiment isn’t to point out that you’re overspending, but that you already have an incredibly rich life, probably one in which you don’t have nearly enough time to follow up on all of the pleasures already available to you. How many series and movies are in your Netflix queue? How many unread books are on your shelves? How many barely-worn items of clothing are jammed into your closet? How many cool projects are stowed away somewhere? How many things have you wanted to do and bought the stuff for, but then realized you just didn’t have the time?
What does this have to do with credit card use? It’s simple. It is very hard to use a credit card effectively if you truly believe you don’t have “enough” in your life already and that you really need or deserve “more” to feel happy. If the idea of simply putting a cap on all of these pleasures in your life seems difficult or hard or deeply unappealing, then it is going to be very hard to use a credit card responsibly.
If that describes your feeling about life, ditch the credit cards for a while. A credit card in the hands of someone with those kinds of feelings about their life is a dangerous tool, indeed. It’s basically a recipe for consumer debt.
If you can see the abundance that your life already has to offer, the next step is to put a firm limit around those wants. Cut back on some of those wants that come in the form of a monthly bill if possible, and then put some caps on your spending on those other things. Eat out a little less frequently and maybe at cheaper places. Stay in for movie night a couple nights a month instead of going out.
The strategy that has truly worked well for me is to put a strong cap on all of my incidental spending each month. If I’m buying something that isn’t necessary and isn’t directly discussed with my wife, it counts toward my monthly “hobby spending” limit. I track this by keeping a running tally in my pocket notebook – if it’s an incidental purchase, I either write it down immediately or stick the receipt in there to write down later. If I slip up and “go over” for the month, then I carry it forward to next month.
Everyone’s budget is different, so I won’t set a specific dollar amount for you. Some people have rent, others have a mortgage, and others own their home. Some people are facing car payments, while others are not. Some people are pushing hard for their savings goals, while others have them a little more on the back burner. Some are paying off student loans, while others are not. Some live in a high cost of living area, while others live in a low cost of living area.
The only rule that applies here is to give yourself enough so that it feels like breathing room and freedom, but not enough that you’re going to continue down a path of financial trouble.
The real goal here isn’t the limit. The real goal is to make you stop and think about your non-essential purchases and ask yourself whether they really add value to your life. Every single time you pull out that credit card, that question should be on your mind. “Does this really add value to my life? Does it add enough value to be a part of that incidental spending limit for the month?”
This is the single most important thing you can do when it comes to credit card use. Be mindful of everything you put on there and set some reasonable limits for yourself so that you don’t inadvertently overspend. If you do that, you’ll avoid the vast majority of credit card problems.
In the end, the best way to get maximum value out of your credit card is to exhibit self control. If you’re purchasing more than you can afford with the aid of a credit card, eventually you’re going to be facing down a mountain of debt with hundreds of dollars of interest accrued per month.
If you’re consistently spending within your means, you’ll soon reach a point where there is always more than enough in your checking account to pay off your credit card in full each month – and that’s exactly what you should do.
Another thing worth considering is choosing the right credit card. In general, it’s not all that useful to have lots of different credit cards, because you’re adding management effort and identity theft risk with every card you add. (There are some strategies that involve using lots of credit cards, but that’s a separate topic entirely and it’s a strategy that can easily backfire if not played carefully.) Instead, it’s a good idea to just have one or perhaps two cards that are carefully chosen to maximize value.
The most effective way to do that is to choose a card or pair of cards that offers you maximum benefit for the retailer(s) you use the most while still offering some benefit elsewhere. In other words, you want a Visa or MasterCard or American Express card that you can use at other locations besides your primary retailer, but the card offers really strong benefits associated with that retailer.
Cards like this are generally not listed among the “best” credit cards because, frankly, they’re hard to evaluate and they’re different for each person. Cards that are mentioned among the “best” cards are the ones that offer the best benefits without association with a particular retailer, but if you do a large portion of your shopping through a single retailer or two, a card associated with that retailer is going to be a tremendous bargain.
Let’s say, for example, that you shop at Target quite frequently, doing your grocery shopping and household shopping there. The Target REDCard Mastercard gives you 5% off all of your purchases there. A Costco credit card gives you 4% off all gas bought at Costco and 2% off of all other purchases there (and 3% off of restaurants and other specific purchases), so if you buy gas at Costco, it’s pretty hard to beat that for a fee-free card, especially if you commute. If you shop on Amazon a lot for household supplies and nonperishable foods and have an Amazon Prime account, the Amazon Visa gives you 5% back on all of your Amazon purchases in the form of Amazon credit.
Those discounts are really hard to beat in terms of a general purpose card. You can beat them with some introductory offers if you jump through lots of hoops, but those introductory offers rarely translate into lasting benefits.
What if you can’t clearly name a preferred retailer? If that’s the case, then one of the best rewards credit cards makes sense.
What about APR? Here’s the thing – if you are using a credit card effectively and getting maximum value from it, the interest rate does not matter because you’ll never be paying it. Interest rates on credit cards only matter if you carry a balance from month to month, and if you’re carrying a balance from month to month, you’re already not getting the maximum value from your credit card.
In summary, the cornerstones of successful credit card use are mastering where your money goes, consciously limiting non-essential spending, using a sensible card, and paying it off in full each month. If any of those cornerstones fail, then you aren’t getting maximum value out of using a credit card. If multiple ones fail, then you’re better off using your checking account and debit card to pay for your expenditures, because your credit card is definitely costing you money.