The Use and Abuse of Credit Cards

The Use and Abuse of Credit Cards
By Paul Commins (TMF Buster)
January 29, 2001

At The Motley Fool, we generally consider credit cards a primary source of personal financial difficulties. As stated in Step Two of our 13 Steps to Investing Foolishly, "Credit card debt remains probably the single best answer we know to the question, 'Why can't I ever seem to get ahead?'" Between the tiny minimum payments credit card companies require, and the interest rates of 16% to 21% they charge, millions of Americans get caught in a seemingly endless cycle of paying off credit card debt. (If this applies to you, check out our recent Special on paying off credit card bills).

As a result, our general attitude towards credit cards is: pay them off every month, and use them sparingly. However, recently we received reader feedback from another point of view. For those able to pay off credit cards regularly, there are ways to use them to your advantage.

For example, we recently included the following reader comment -- which we took from one of our discussion boards -- in one of our regular email newsletters:

"I just wanted to point out that credit cards aren't as bad as you make them out to be. You say you only use credit cards if you have to. I believe in the opposite -- I use my Yahoo! Visa or Discover card at every possible opportunity, even when buying my $2.39 lunch. My wife does the same.

"Then, we get a bill from First USA and Discover every month for $1,200 or so, due in a few weeks. You know what my wife does? She writes a check from our Waterhouse Securities money market checking account, puts it in an envelope, and notes on the outside of the envelope the last possible day to send in the check (usually 7 days before due, I believe).

"This means that we pay for most of the stuff we buy more than a month after we receive it. We average about $1,500 in debt at any given time. But, the funny thing is, we pay 0% interest on this debt, and because of the debt, our money market account has roughly $1,500 extra in it at all times. That works out to about $70/year extra cash, beyond the 1% cash back and 1% gift certificates we receive.

"So, while your system is good, I believe you are missing out. Interest-free debt is not a bad thing, as long as you are not living from paycheck to paycheck. If you don't trust yourself to pay off the bill, then by all means, take your credit card out of your wallet. But, once you can trust yourself, I believe a smart move is to start taking money back from First USA. Believe me, I feel no burden whatsoever from my credit card debt."

We were a little surprised to see our email coffers swamped by strong reaction -- both pro and con -- to this reader's story. As we sift through the mail bag, we find it fascinating to read the crafty plans people come up with for profiting from credit card use, but most poignant are the pleas from credit counselors and their clients who know first-hand the pain of a life ravaged by an inability to manage credit card debt. Here's a sample:

"In my experience working with numerous couples with debt, I can confidently say that Steve's plan will not work for a majority of people. The 70 bucks a year in savings will not balance out the psychological risks most people have with plastic. The mind factor is what we need to be focused on, not just the numbers. I have found that more people have more money if they learn to pay as they go and apply solid principles to finance rather than trying to benefit from credit card companies with 30-day lag times."

To get a close-up look at the credit-card-related hardships endured by a lot of everyday, ordinary people, check out our very popular Consumer Credit discussion board. This might be our most Foolish board community, where recovered credit card slaves regularly contribute to the recovery of newcomers, amidst the constant exchange of practical -- and often the most current -- information on the nuances of credit rules.

How do we responsibly share this feast of reader feedback?
In the Foolish spirit, we decided to present the leading arguments from both sides. As always, you, Fool, make the final call. So, for some strategies to make credit cards work for you, as well as some cautionary words, click the link below.

Most personal finance experts agree on one thing: successful money management begins with a budget. Unless you take the time to map financial inflows and outflows, however crudely, it becomes difficult -- if not impossible -- to make sound money decisions. Credit counselors often prescribe a strict regimen of cash payments, from envelopes labeled by budget category. Envelopes are replenished on payday according to an agreed-upon budget plan. The goal is to drive home clearly -- and viscerally -- the limited parameters of your personal financial fiefdom.

The dark side
If you let them, credit cards can undermine this basic discipline by masking the true average level of outflows from your family coffers over time. Moreover, they can enable a habit of spending beyond budgetary limits by removing the immediate consequences. Any good behavioral psychologist can tell you that the elapsed time between reinforcement and the activity that is being reinforced, either positively or negatively, should be as little as possible -- the closer to instantaneous, the better.

When it comes to budget discipline, we Fools are particularly interested in saving some room for dessert. Unfortunately, if you carry credit card debt, someone else is probably picking at your dessert, although it's easy to overlook this devious thief. Unless you've locked in a bona fide sweetheart deal on your interest rate, chances are excellent that the money you are earning on your regular savings is overrun by the higher interest payments you make on your credit card. Bill Mann paints a clear picture of this dilemma in a Fool on The Hill column from last year: "Compounding is a Double-Edged Sword."

The light
However, there may be ways to make credit cards work for you. Here we list the potential benefits of credit card use suggested by our readers. One caution applies, however, across the board: the assumption underlying each benefit is that the card balance will be paid in full each month, and that finance charges will be nil. If this assumption does not describe your current status -- or the strength of your habits -- then all of these benefits will have to be weighed against a financial cost. We'll let you make the final call, although in many cases this cost will be prohibitive.

Without further ado, ways to benefit from extensive credit card use include:

Earning rewards based on the amount you charge. Common benefits are year-end cash payments, participating retailer discounts, and airline frequent flier miles. The more regular monthly bills you pay by credit card, and the fewer credit cards you use, the more likely you are to earn such rewards.

Regularly borrowing -- for free -- a month's worth of expenses. When discussing equity investing, we emphasize the importance of a company's working capital management when it comes to sizing up a stock. Similarly, a family's Foolish Flow Ratio can be improved by delaying cash outflows as long as is prudently possible. As a very rough frame of reference, $2,000 worth of delayed monthly payments over the course of one year would net $120 in interest income, before taxes, assuming a 6% return.

Delaying big purchases until the first few days in a new payment period. For example, if your credit card bill covers purchases from the 1st to the 31st of every month, and your payment due date isn't until several weeks after you receive the bill, purchases posted during the first few days of each month won't come due for almost two months. One reader suggested that this angle can really be played to advantage during the holiday season, when two months' worth of interest earnings on amounts purchased will generally bring the biggest return.

Using free online bill-payer systems to ensure reliable on-time payment. By entering credit card bill payments the day they arrive, but post-dating the payment date until a short time before the due date, you can ensure that you pay on time, but not any earlier than necessary. This eliminates much of the worry and risk associated with trying to time card payments to your advantage. It also eliminates postage and check charges for bills regularly charged to your credit card.

Taking positive steps toward building a strong credit score.

Safely and conveniently carrying less cash and no bulky checkbook. Contrary to popular perception, credit cards can actually be safer than cash, checks, and debit cards. Credit card companies typically assume liability for fraudulent charges beyond $50, provided you have acted responsibly and reported the charges promptly.

Enjoying the advantages of e-commerce. In an effort to spur online charges, some credit card companies have even waived the standard $50 consumer liability. The Web further tips the safety balance in your favor by providing quick online access, for most credit cards, to a daily update of charges to your card.

Painless organization of spending records for budget tracking. Most credit cards now assign charges to merchant categories and provide Web download routines for easy transfer of categorized monthly statements into leading personal finance software.

The card most frequently mentioned in our reader email was the Discover Card, which pays 1% cash back on your annual card purchase total beyond $3,000. Moreover, Discover has a top-flight website that offers all the goodies -- daily updates of posted purchases, statements organized by category, the ability to sort transactions by date or category, easy online payments drawn from your checking account, selectable email reminders for payment dates, low available credit, and easy downloads to Quicken and Microsoft Money. Plenty of other card companies offer these types of services; be sure to take advantage of all the services your card offers.

Your decision
We've tried to emphasize both the pros and cons of frequent credit card use. Only you can weigh them in the context that matters most -- yours.

If you like the list of credit card benefits, but are a little wary of the temptation, it might be best to start out slowly. Many in the less-than-glamorous crowd of creditors -- such as utilities and insurance companies -- offer the option of payment by credit card. This might be a good first step, as using a credit card for these bills is unlikely to tempt most people (ever heard of an insurance-purchasing binge?). If this works for awhile, you can move to other spending categories as your confidence grows.

Ultimately, though, it all comes down to how well you know yourself and your particular basket of human weaknesses. In the end, only you, Fool, can make the calculation.

One final word -- thanks to all the community-minded Fools who took the time to offer their perspective on this popular topic, especially to Steve Koch, Robert Novak, Sean Boyd, Frank Krider, and Mary O. from Austin, Texas.

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