I’ve heard and read various people defending credit cards for various reasons.  They claim that as long as you pay your credit card bill in full each month they can provide some good benefits.  Things like being safer than cash, car rental insurance and point programs for free flights, etc.  The one reason that is often even me that interests me in particular is that credit cards provide free short term loans.  After thinking about this for a while I decided I wanted to see if this is even a worthwhile reason to list.

Now assuming that you are just dealing with regular personal finances and not some business or investment opportunity that you can “flip” in time to pay off your credit card bill the only real benefit in getting this free short term loan is from the time value of money (TMV).  The basic logic of TMV says you should postpone cash out flows as long as possible and collect incoming cash as soon as possible.  So using credit cards to basically give you free 30 day terms on your expenses might make sense but is this really getting you that much extra cash flow?

For example: instead of paying your expenses as they are due with the cash in your checking account you put those expenses on your credit card and allow that cash to stay in your account and earn interest until it comes time to pay your credit card bill.  Your monthly expenses are $2,000 and the interest on your savings account is 1.5%.  I’m assuming your money will be most likely sitting in your savings account or something similar since 30 days is too short a period to really be able to put it anywhere else for a better return.  This would only net you $3.75 a month and assuming you just didn’t spend it, about $45.31 a year.

This isn’t really life changing money.  Plus this doesn’t even takes into consideration the expense on that income such as tax.  Most people lose this amount of money regularly from random small impulse buys.  Things like random snacks or coffee.

Now let’s look at what kind of risk this $3.75 opens you to.

If you miss one payment you pretty much wipe out your entire profit or more with the late fees and penalties that the credit card company will charge you.  In addition it puts your credit score at risk which will cost you even more down the road.

Things can get out of control and you don’t pay off the bill in full.  Credit card companies aren’t completely stupid and they wouldn’t be offering this “free” short term loan unless it provided some sort of benefit to them. I look at this like the drug dealer giving out the first one for free.  They know that once they get you hooked there is a long road to recovery.  That combined with America’s culture needing everything yesterday and a lack of self control makes this a dangerous combination. Plus at 14% interest rates you will quickly lose any profits.

For the common person I don’t think that the benefit outweighs the risks.  But when it comes down to it, a lot of smart financial decisions are about knowing who you are and being honest with yourself.  You know if you are the type of person who has the discipline and self control to minimize the risks or if you are the person who will forget to make payments and let spending get out of control. If you can handle the risks and you think the additional benefits mentioned at the beginning of this article make credit cards worthwhile then go for it.  Just don’t kid yourself into thinking the credit card companies are giving you a great deal on a free short term loan.

-T!

In my opinion the credit card is a devil’s invention. Of course paying by card is very convenient, I do so, but why do you need credit? Why not use a debit card instead and spend only the money you have? You may say that the money you have is not enough… then cut your expenses! In such a situation the problem is not how much you spend but rather what is the positive difference between your expenses and income. If you always spend more than you make then credit won’t help!

I have a friend in Ukraine who had a very sad experience of when she decided to use credit cards. When she opened her first credit card she was excited about how easy and convenient it was to use. In a month, when the credit card bill arrived she was about as depressed as she was excited one month before. She couldn’t pay in time and the bank charged her humongous past due fees as well as interest, which is 30-50% for credit cards in Ukraine. She had to spend all of her income for a month to cover the balance, fees and interest!

I’m not saying that you shouldn’t use credit cards. You can use them if you are ready to take on all of the associated risks. However, I don’t think I will ever use credit cards…

-O.