How To Use Credit Cards To Your Benefit
Most of us have a credit card or three. We get them at different times, for different reasons, and use them at different times, for different reasons. But how many of us have a strategy for our credit cards? Without a little planning, credit cards can be a rosy path to self-destruction. For proof just watch an episode of Suze Orman’s show and count how many callers admit to thousands and thousands of dollars of credit card debt. I’ll wager they aren’t all just bad, irresponsible people. But I will bet that not one of them had a plan of what they were going to use that credit card for when they first opened it.
On the other hand, people who dismiss credit cards out of hand are literally walking away from real value. If you know you are an irresponsible person who can’t resist the need to buy things to make yourself feel good, then yes, avoid credit cards at all costs. Getting deep in consumer debt is never going to be a good thing. But if you are a reasonable person who wants to optimize their financial situation, the strategic use of credit cards can provide lucrative benefits.
I’ve had a few people recently ask me about how to best strategize their credit card use, so I thought I’d go through some of the different types of cards and some scenarios of how to best utilize them as a tool in your financial independence arsenal.
BASICS: HOW CREDIT CARDS WORK
The concept is relatively simple, even if some of the details get complicated. When you apply for a credit card, a company like American Express, or a bank like Chase, or a department store like Macy’s, take a look at your credit score. Basically they want to know that if they extend you credit that you are likely to pay it back. The better your score, the higher the amount of credit and lower the interest rate they might offer you.
Then when you go to the store, rather than paying outright for items yourself, the credit card company/bank pays your bill to that merchant for you, up to your credit limit, and you are responsible to pay back the company/bank. Generally, if you pay in full at the end of the monthly billing period, you only owe the amount borrowed. If you exceed this period though, the company then charges you interest for the privilege of postponing your payment.
This interest rate is widely variable and dependent on a variety of factors. I’ve had credit cards that charged 8%, and I’ve had ones that charged 28%. If you are going to carry a balance, which I’d never recommend, it is up to you to know what this rate is on your cards, because you might want to use one card over another.
Each month your bill will have some kind of minimum payment to show the company that you are making a minimum of effort to keep up with your bill. One could argue that the bank hopes you only pay the minimum payment, because then you end up paying significantly more over time in interest payments over your original purchase. Hint: Never pay just the minimum payment. And whenever possible, pay the balance in full.
WHY ARE YOU OPENING A CREDIT CARD?
There are several reasons you might want to open a credit card.
1. You spend more money than you make every month and you are looking for something to bridge the gap. KIDDING! This would be a very foolish and short-sighted use of credit cards, but you already knew that, right? RIGHT??? Seriously, if this even remotely seems like a good idea, do your future self a favor and thunderpunch yourself repeatedly until you stop talking like a crazy person. Or, as it is known in many sad circles, “a normal person”. Fortunately, I doubt anyone reading this blog aspires to be normal.
2. Convenience. At most merchants, paying with a credit card is now the simplest and quickest option. Who wants to deal with ATM’s and carry cash in their pocket? And anyone who writes a check is sure to draw the ire of every person standing behind them in line. Those people are also walking away from the benefits credit cards offer.
3. Rewards cards. Credit card hackers will optimize the cards they carry so that the majority of their spending is on cards that give them the best benefits, as detailed in the next section.
4. Credit card benefits. People often forget about the added benefits that come with using a credit card. These benefits vary with each type of card, but can include things like refunds on products that break or get stolen within a certain timeframe as well as various types of travel insurance or insurance on rental cars. They may also offer extended warranties, extended return periods, or price protection guarantees. Be sure to read the fine print, but these can be some valuable benefits and a good reason to use a credit card over a debit card or cash.
5. You want to take advantage of 0% interest rates as a short term loan. This concept is a little complicated, but you may have heard people talk about it so I’ll mention it briefly. When interest rates are high, people will sometimes take loans at zero percent, put the money into a short term CD and pocket the interest, paying the loan back in full at the end of the 0% grace period. But in todays market where interest rates remain so low, this isn’t a very useful strategy. Also, watch out for fees associated with cash advances, which are often in the neighborhood of 3%!
BRANDS OF CREDIT CARDS
The most common brands of credit cards include Visa, Mastercard, American Express, and Discover.
THE ECONOMICS OF CREDIT CARDS
Credit card companies act as a middle man. When you buy something with their card, they pay the merchant, freeing the merchant from having to worry about customers paying by check, and providing a convenient way for the customer to pay, which merchants and customers both prefer. They also provide protection for the customer, who can stop payment if a transaction is in dispute or if the card is stolen.
Credit card companies make their money in two ways. First they make money from customers who do not pay their balance in full every month and pay interest on the amount of the loan they have taken. They can also charge hefty fees and penalties. Fees for a late payment, fees for going over your credit limit, fees for taking a cash advance, fees for balance transfers. If your goal is to give your money to the credit card company, then feel free to use them the way most people do, as a cash advance to buy things you can’t afford. If, on the other hand, you want to make credit cards a tool that you use to get ahead, then pay your balance in full every month, because you never want to pay interest or fees or penalties of any kind.
They also charge the merchant a fee, often something like 2-3% of the total purchase price. Merchants don’t like this fee of course, but they pay it because customers like the convenience of using credit cards, and stores that don’t accept credit cards are unlikely to grow beyond a small group of loyal customers who are willing to put up with the inconvenience of not being able to pay with a credit card.
American Express and Discover charge a higher merchant fee than Visa and Mastercard. This means they sometimes can offer higher rewards back to you, but it also means that there are more merchants who will not accept them for payment.
TYPES OF CREDIT CARDS
There are several types of cards you might be interested in, depending on your circumstances.
Charge Card vs Credit Card: A charge card must be paid in full at the end of every month, and does not offer the flexibility of a credit card to spread the payments out.
Pre-Paid Cards: These are usually for people with poor or no credit. They make a deposit in a bank, and their credit limit is whatever the amount of money they have in that account. Since you are putting up the collateral, this isn’t what people think of when they are looking for a credit card, but it can be a great way for people just starting out to build a credit history.
Low Interest Cards: These cards are designed to always have a (comparatively) low(ish) interest rate attached to them. Obviously these would be more attractive to people planning on carrying a balance. Hopefully, if you are one of these people, you won’t be for long.
Of more interest to Credit Card Hackers are the rewards cards. Of these there are also a few different types.
Cash Back Cards: There are a few cards that give you cash back on your purchases. Sometimes it will be a set number, like 1.5% on all purchases. Sometimes the card will have rotating rewards categories, so for three months you get 3% or even 5% back on gasoline, or department stores, or whatever the promotion is. Hacking these cards can take a little effort to remember which card has what deal, but obviously getting 5% back can be worth some effort.
Airline/Hotel branded Cards: These cards are affiliated with a specific airline or hotel, and instead of cash back, they give you frequent flier miles/hotel points towards that particular program. Depending on how you use them, and how much you travel, these cards can be fairly lucrative for Credit Card Hackers if you can optimize your miles. They can also have added benefits of waiving fees for checked bags and priority boarding on airlines, or free upgrades or other benefits at hotels.
Hybrid Cards: Some cards offer cash back, but if you use your credit towards purchases for certain things, you may get a bonus. For example you maybe get a 10% bonus if you opt for a gift card for a specific retailer, or a similar bonus if you use your credit for travel expenses that you pay for with your card.
“Points” Cards: Several companies, such as Chase, American Express, and Starwood, offer points cards. Instead of airline miles or straight cash back, you get points in their system. These points can be used towards purchases in their proprietary portals to shop, or can sometimes be converted to cash or transferred into partner airline or hotel programs. These programs sometimes give you more flexibility than standard reward cards, but since each program is different, you need to know what your options are before you decide which one to apply for. (For example, Chase points can be transferred into United Airline miles, but not to American Airlines.)
Merchant Cards: Many big stores, such as Macy’s or Costco or other chain stores, will offer their own branded card. These cards often will give you a bonus of an extra 10% or so off on your initial purchase, and may have access to special coupons or deals at various times. They also tend to have very high interest rates. Generally these are probably not going to be as good a deal as a regular or reward card, but it will depend on your needs and buying patterns.
Personal vs Business Cards: Many cards will offer a personal and a business version of the same card. For most people, you will want to apply for a personal card. But if you have a business (which can even be a home business like selling things on eBay) you may qualify for a business card as well. If you are looking to maximize benefits, and you have a legitimate business (even one just starting out), you could qualify for a business card as well as the personal card.
SIGN UP BONUS
Most of the rewards cards will offer some kind of sign-up bonus. This can vary from 25-100K worth of airline miles to an actual cash incentive depending on the card. Before applying for any card, take some time to research what bonus is currently on offer. Many of the more lucrative offers come and go with some regularity, and you will want to try and time your applications, when possible, with the best offers. In other words, don’t apply for a Southwest Airlines Card with a $100 cash-back bonus, when with a little patience you could get one of their frequently offered 50,000 mile bonuses, which is worth over $600 in free travel.
Some cards have an annual fee you have to pay just to have the card in your wallet. These tend to be on rewards cards, and can range from $59 to $395 a year. Check the fine print, as some promotions will waive the fee for the first year, but not always. Sometimes the yearly fee will come with an “anniversary bonus” that, depending on your needs, may make the card worth holding onto. Some may not.
YOUR CREDIT SCORE
Your credit score is probably more important than you realize when it comes to your life. Not only do credit cards companies look at it to determine your eligibility for loans, but so will mortgage companies, landlords, and even potential employers. Exactly how this score is calculated is complicated and, to the good people at FICO, a proprietary secret formula. But there are some basic tips to keep in mind. As a general rule of thumb, refrain from opening any new accounts for the two years preceding any major purchase such as a house or even a car. This is important, because the more likely you look (on paper) to repay a loan, the lower the interest rate they will charge you. Recently opening up new credit is a red flag that perhaps you are having trouble paying your bills, and could result in an expensive increase in your interest rates.
If you don’t have major purchases on the horizon, this isn’t as much of a concern. Applying for credit will cause a minor drop in your score. But this drop will disappear within a few months. Also part of your score is based on the calculation of how much credit you have been granted by all companies compared to the amount of credit you actually use. So someone who has a total of $10,000 of credit on two cards and carries a monthly usage balance of $5000 is using 50% of their available credit. They are going to have a lower score than someone who has $100,000 worth of credit on ten cards but still has a monthly usage balance of $5000, which is 5%.
It is also a good idea to find a no-fee credit card to open and keep forever. The longer your credit history goes back, the better your score. Even if the card doesn’t offer any rewards, use it occasionally just to remain in good standing so the credit card company doesn’t close your account for non-use.
Conventional wisdom would be to pay close attention to the varying interest rates the various cards offer. As stated previously, this can vary as much as 20% or more between different cards, so can make a huge difference if you are carrying a balance month to month. But I haven’t paid attention to this metric in years. Can you guess why? I pay my bill off every month, so haven’t paid an interest fee in probably ten years.
HOW TO OPEN A CREDIT CARD
1. First, you need to determine what need you are trying to meet with opening a new card. Review the types of cards available, and decide which are going to help you meet your goal.
2. Check your credit score. The better your credit score, the more likely it is you will be approved for a credit card. If you have terrible credit, you don’t want to make it even worse by applying for a credit card that you are just going to get denied for anyway, further damaging your score. Short hand: “Average” credit is 600+, “Good” credit is 700+, and “Excellent” credit is 780+. If your score is in the 600s, google the credit card you are looking for to see what others have been approved for. For example, my un-scientific googling shows that Wal-Mart prefers a credit score of 620+ while Nordstroms prefers 685+. Retail merchant cards will generally accept a lower score than bank branded cards, and will have a higher interest rate to match the added risk!
3. You can apply online, at a bank, or via mail. Online applications frequently (but not always!) will give you instant approvals which can be convenient.
4. You generally will need your social security number, and an estimate of your yearly income. Tell the truth!
5. If you get denied, be prepared to call up the reconsideration line. Sometimes you can clarify a point to get the card approved. If you have multiple cards with the same company, sometimes you may need to close an old account you no longer use or move credit from an old card to the new one.
6. Business cards will frequently require a phone call to a representative. They may ask you about your business, how long you have been running the business, how much money you make or anticipate making, and how big of a credit line you anticipate needing. Again, always tell the truth, but remember, they want customers.
For many of the rewards cards, there will be a minimum spend associated with earning the reward. So in order to get the advertised 50,000 mile bonus, you have to spend $3000 on the card within the first three months, or something like that. It will be your responsibility to keep track of this. If you call in to a representative they should be able to confirm the details of what the requirements were when you signed up, but otherwise the company will not give you any reminders about meeting the deadlines, nor will your bills have any tally or information about this at all. It is a good idea to take screen shots of your application page that shows these details so you can remember them yourself. And then don’t wait until the last minute! Once you meet the minimum spend, your rewards may take 2-6 weeks to post depending on the company and where you are in your billing cycle. When in doubt, give customer service a call to confirm.
Also, check the fine print, but often balance transfers and cash advances and annual fees do not count towards minimum spend. Your minimum spend usually has to come from another merchant, so that the credit card company is making money off of them to fund your reward!
THE RIGHT WAY TO USE YOUR CREDIT CARDS
1. Pay your balance off every month. Really. If you aren’t ready to do this, then you aren’t ready to use credit cards, much less go for credit card hacking. Rewards cards in general have very high interest rates attached to them. So if you are paying interest, beyond losing all the value of the rewards you are supposedly earning, you will end up paying more than if you had gotten a low interest card to start with. In other words, earning 2% cash back is meaningless if you are then paying 25% interest on that purchase.
2. Pay attention to your minimum spends. Don’t lose track and then forfeit the reward you were counting on. If you can’t find a way to make the minimum spend on any given credit card (which sometimes are as high as $5000), then don’t bother applying for that credit card. The advertised reward is meaningless if you don’t get it.
3. Once you get your card(s), move all your spending away from no-reward debit cards and direct bank transfers, and put all your spending on on the credit card. This includes your monthly bills such as utilities, your Netflix account, cell phone, whatever. Make sure you are taking full advantage of the benefits your card(s) offer. THEN PAY IT OFF IN FULL EVERY MONTH.
4. Review your statements, and call customer service if you have a problem. No one else is going to be looking for mistakes or fraud for you. (Well, unless the fraud is blatant or otherwise suspicious, in which case you might get a call from the security department.) But if you see a mistake, or a charge that isn’t yours, call in. I once mistakenly paid my credit card bill early, a day before the billing cycle actually ended, which caused me to get a late fee the next month because then I didn’t make a payment at all during the next cycle. (I often pay my bills early, but this was TOO early.) I called in and explained the situation, and they cleared it up. But you have to call and ask.
5. Some people use travel cards to earn travel rewards in specific programs. Others find more benefit in sticking to cash back cards and then using that cash to pay for travel tickets (that then don’t come with blackout dates or are limited to one airline or hotel brand). It just depends on your needs which will be more useful to you. Don’t just do what others tell you to do, do what actually works better in your situation.
6. Once you have them, use them! I roll my eyes when I hear stories about people putting their credit cards in blocks of ice or cutting them up so they don’t misuse them, as if they are toddlers who can’t possibly be expected to act in their own best interest against the irresistible temptations of a trip to McDonalds or The Gap that they can’t afford. But if you were still at that level, then you wouldn’t have made it this far through the guide anyway. That said, if you know you have a problem, putting them in a block of ice is better than closing the account altogether, so do it if you must.
ADVANCED TRAVEL HACKING
For those who have demonstrated financial competence and are ready to go deeper, there is another level of hacking. This guide won’t cover advanced card hacking in depth, but even if you don’t plan on going this deep, the concepts can be informative.
Rather than applying for one card at a time, you can apply online for multiple cards at once. When the banks check your score, they will see your previous applications from last month or even yesterday, but they may not see one from five minutes ago, which makes it more likely that you will be approved for multiple cards. This is commonly referred to as an “app-o-rama”. Others, referring to the fact that with some cards (but not all!) you can be approved over and over again and still get the sign-on bonuses multiple times, call it credit card churning.
At this level, you need to be more savvy about which cards you apply for at a time. Many of the best rewards cards, for example, are from Chase. But you have to remember that while Chase wants your business, it doesn’t want to approve you for thousands upon thousands of dollars in credit and give you hundreds and even thousands of dollars worth of sign-up bonuses if you aren’t going to be a good customer to them. So don’t plan on opening up every single Chase card there is all at one time. Though there are always exceptions, in general you will probably only want to apply for a single personal card and, if applicable, a single business card from any one company at a time.
So for any given app-o-rama, you might apply for a card from Chase, one from AmEx, one from Citibank, one from Barclays, and so on. (Also check out US Bank, Capitol One, Bank Of America, and even some Credit Unions.) Remember to keep in mind your minimum spend you are committing to with your applications. The point isn’t to get as many cards as possible, the point is to maximize your rewards. If you can’t meet the spend, there is no point!
Again, convention is that you don’t want to open new credit within the 2 years prior to applying for a major loan such as a car or a house. But otherwise, as long as your credit score is good, many people can get away with a well-planned app-o-rama as often as every three to six months.
At this point you are probably going to want to create a spreadsheet, so you can track all your cards, note the necessary minimum spend and your progress towards meeting it, as well as any annual fee and when it comes due so you can call and cancel the card the month before if you don’t think it is worth it to keep. This level of hacking is not for the disorganized.
There are tricks people use to maximize spend to earn additional points (sometimes called “manufactured spend”), and to negotiate approval on cards they initially are denied for, and how to know which cards can be churned and which can’t. One great resource for up to date information are the forums at flyertalk. These forums can be overwhelming for the newbie, but with some patient digging you can find a wealth of information. Some of the information here may, from time to time, cross the line from tricks that everyone should utilize to “tricks” that feel more like “scams”. If you feel bad about it, don’t do it! If you don’t understand it, don’t do it! At the same time, remember that rewards programs have proved to be incredibly profitable for the companies who run the programs. Learning how to maximize your benefits is not something to be embarrassed about.
Remember, credit cards are a tool. They can provide convenience and support and sometimes lucrative rewards. But if not used responsibly, they can ruin your financial standing. Before opening any card, make sure you are being honest with yourself about your ability to only use the card for good.
Have a plan.
Pick the best card(s) that will help you accomplish that plan.
Pay attention to interest rates, minimum spends, annual fees, etc.
Stay organized. (Automatic bill pay can really be your friend.)
Reap the benefits.
Still have questions? You’re probably not the only one, so ask below!