Saturday, 21 July 2007

When a Credit Card can be a Good Thing

Many PF blogs are concerned with paying off debt, including credit card debt. This is a valid approach to increasing your wealth if you are starting out from a position of indebtedness, but can become counterproductive once you've cleared the decks of you debt and are accumulating a positive net worth. While you always have to remain on guard against using credit cards to buy "things" that you don't really need (especially if you also can't really afford them), credit cards can be a useful tool in your financial kit if used carefully. There are several ways in which a CC can be a useful tool:

* I have one credit card which I use for all my day-to-day expenses (grocery shopping, petrol, paying utilites etc). It has a low annual fee and a free rewards program (cash back credit cards) that earns me enough points to redeem for a couple of hundred dollars paid off my credit card each year. As long as I always pay off the balance each month I'm actually making money by using a CC instead of cash to pay my bills. The trick is to only buy the things you'd be paying for anyhow, otherwise you can easily build up a CC balance which you can't afford to pay off in full each month. I've also got an Amex card which I use overseas for paying hotel bills, meals and so on. I may cancel this card one day as it has an annual fee of around $100 a year (being a "gold card"), and my everyday credit card is now a VISA card which can be used overseas - when I first got my Amex card more than twenty years ago my day-to-day CC was a "Bankcard" which was only able to be used within Australia and New Zealand (and not all merchants accepted it in NZ either!). Bankcard was shut down and was replaced by a VISA card last year, so there's no longer any need for my Amex card - aside from nostalgia and some warped sense of "value" provided by a "gold" card. These days a "gold card" isn't even a status symbol - for that you'd need a platinum, black, or gold-pressed latinum card for some vast annual fee! It's important to compare credit cards to determine which one offers the best features for the lowest cost.

* Another benefit I've gotten from credit cards in recent years has been making money off 0% balance transfers deposited into online savings accounts earning 5% or 6% interest on OPM. In Australia there's no such thing as a "credit score", so getting and using these cards has no impact on the interest rate you pay on other borrowings, and little effect on how much you can borrow for a home or investment loan. If you do make use of CC arbitrage to earn some extra income on the side, it's important to avoid cards that have an annual fee or where a fee is charged for the balance transfer. You also have to ensure that the minimum amount due is paid each month during the 0% period, and that you pay off the remaining balance before the 0% offer period ends.

* Using a credit card to pay everyday expenses can make it easy to track expenses for budgeting. Rather than having to use a notebook you just check through you monthly CC statements.

* Instead of an emergency fund. Once you have a positive net worth you probably have enough money invested to get you through an emergency. The problem will be that some investments may be hard to liquidate in a hurry. However, from my point of view it makes more sense to just use my CC for an emergency expense rather than keep cash in an at call account. Even though you can get an online savings account that pays a good interest rate these days, it is still less than you'd hope to make from investing in other assets such as stocks, real estate etc. In any event, once an emergency expense has been charged to my CC I have time before the monthly bill is due, so I can carefully consider which investment to liquidate to cover the expense.

Even if you've had problems handling credit cards responsibly in the past, I think many people would be better off learning to use a CC the "correct" way once they've paid off all their consumer debt, rather than avoiding CCs completely for the rest of their life.

Copyright Enough Wealth 2007

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