DISCLAIMER: There’s a very good reason for me putting that “almost” in the title. Credit cards are, in my opinion, a 100% no brainer for anybody capable of responsibly managing their money. However, if you are even slightly unsure of your ability to do so, they’re not for you. Every single benefit of a credit card is a mere fraction of the downsides that can come from poor management. The #1 rule for this entire concept is to pay off your credit card in full at the end of every month, therefore never incurring any interest, and requiring you to always have the money for your purchases in your account at all times. In other words, even though the money isn’t coming from you right away, if you don’t have £100 in your bank, or if that £100 won’t still be there at the end of the month, don’t use your credit card for a £100 purchase. Credit cards can raise your chances of getting a mortgage, can save you if the holiday company you book with goes bust, and can earn you money at the same time. But, they can also cost you a significant sum of money, or worse, ruin your financial record for years. Read all that back again, and if you’re still interested, read on…
My philosophy with credit cards has been serving me well for several years, and is one I try to impart on as many people as I can. But the truth of the matter is that it’s serious business, and not something you want to make a decision on from a passing comment or a TV advert. So I thought I’d put together a blog post instead, where I can outline how I handle credit cards, how I make them work for me, and how you can do the same thing. Note that this article applies to most countries where credit cards are issued, but is nonetheless based on the system here in the UK, so there may be location-based discrepancies.
For me, my relationship with credit cards started when I began earning a full-time salary from my first real job. That’s not to say you can’t get one sooner (student credit cards exist for this exact reason), but it’s where my experience began. Leading up to applying, the whole thing terrified me. Will people take me seriously paying with a credit card? How do direct debits work? What if X happens on this date and then Y happens, will I be in debt for the next 50 years? As it turns out, they were all unjustified concerns; the system is 99% automatic, all you have to do is obey the golden rule: never buy on a credit card what you wouldn’t buy with your debit card. Basically, if you can’t afford it right now, don’t buy it just because your credit card can.
Paying off the card
I’m going to come to this early on, because it’s important. When you sign up for a credit card, you’ll usually be asked to set up a direct debit (if you’re not, you need to do it yourself ASAP). You should always do this, and you should always select the option that pays it off in full, to avoid incurring any interest (there are cards that charge no interest for the first 12-18 months, but as a matter of principle I always pay them off in full each month anyway). You’ll be asked which day to pay it off (I would recommend right after payday, but allow for bank holidays), and then to sign some online forms, at which point your direct debit will go back to your bank for setup, and soon become active.
Confusingly, you don’t pay off a credit card at the end of the month, as is suggested. What actually happens is that the credit card issuer generates a statement at the end of each month, outlining your purchases (think of this as a bill for your month’s usage). Once generated, your statement is then “outstanding”, and will be paid off by your direct debit. Statements usually have a maximum time period before they have to be paid which is typically 28 days, so in truth, you actually have up to 2 months from paying for an item to it coming out of your bank account (not that this should ever be a factor when you decide to purchase something – see the disclaimer at the top).
Now that the less fun part is out of the way, let’s focus on some of the benefits!
A free credit record boost
Not the most fun benefit I know, but it is arguably one of the most important. Banks and building societies don’t like lending money to anyone who hasn’t been lent to before, and so look at your “credit record” (a list of credit lines you’ve had in the past, and how you’ve utilised them) to determine whether or not you’re a good candidate. This can be a little counter-intuitive, because they are literally looking for people with a history of needing financial assistance, in order to determine whether you’re good with money. Accordingly, it can be incredibly difficult to break into the world of borrowing (which becomes a huge problem when you want to get a mortgage). But you also don’t want to go applying for loans or getting overdrafts just to get a foot in the door, because these tend to indicate poor money management, which, you guessed it, will lower your chances of getting a mortgage. The solution? Credit cards.
By holding a credit card that you spend on (which is effectively short term borrowing) and always pay off in full, you’re demonstrating good money management. You’re holding up a big sign that reads “I’m known to the financial world, I’ve been lent to before, and I paid it off, I’ve got a track record”. But, be careful not to pay off your card early! A common belief people have centres around the idea that using your card but never owing anything on it must be better than owing on it for a month until the balance clears. However the reality is that if you’re always paying off your card, your statement will always be £0, and changes that sign from earlier to read “I’m known to the financial world, I’ve never been lent to, but I have a credit card and I haven’t gotten into debt with it”, which is better than nothing, but not great.
One other quick note here: if you ever fail to pay off your credit card, or have it set to anything less than a full payment, you’ll be borrowing from the bank in a much more significant way, and this will likely wipe off any other benefits to your credit file, so bare this in mind.
Being a particularly frugal and money-savvy person, this was what originally got me interested in credit cards. Certain cards, usually called “cashback” or “reward” credit cards, will actually pay you to use them, in the form of cashback (or often air miles) that builds up in your account, which you can then withdraw as cash, convert to vouchers, or use to pay off your statement balance. This strange practise is made possible by the fees credit card providers charge retailers for processing their transactions, as well as numerous other methods for making money such as annual fees, accidental interest, and of course, data. Cashback rates are normally minimal (the highest standard credit cards nowadays offer a mere 0.5%, or 50p on a £100 purchase), but this all adds up to make a nice bonus after a few months of spending, and is of course, better than nothing.
This is where the biggest spending change comes from for me; I use my credit card for everything. I put holidays on it, I put fuel on it, and I put 50p spends in the supermarket on it, everything. The only thing you shouldn’t use it for is cash (and gambling – which falls under the same bracket). These purchases are treated as “cash advances”, cost a lot in interest, and don’t look good on your credit file (now your sign from earlier will read “I couldn’t afford the basics the other day so I had to borrow cash from my credit card”). This gets a little complicated when using your card as a travel card, but that’s for another post.
One other thing: I mentioned annual fees earlier, and these are important. Whilst many credit cards are free, some can cost tens or even hundreds of pounds, so make sure that the cashback you’ll earn from a card not only outweighs the fee, but that the amount left after the fee is still more than you could have gotten anywhere else.
Ever hear those stories of families who save for years for their dream holiday, only for the company who sold it them to go bust, and for them to get nothing back? How about that time your friend bought an expensive item from a retailer who proved near impossible to contact when it came time to getting a problem fixed with it? Both of those situations play out very differently if you pay using a credit card.
The first big difference is that it’s the credit card provider’s money (usually a bank), so instead of you going up against the retailer alone as an individual, the multi-million-pound company or banking institution is! More often than not, upon receiving a complaint, the provider will reimburse you the value of the purchase, ask you for the details, and then go after the retailer themselves. Minimal effort for you, minimum time to be reimbursed, and maximum chance of it ending up in your favour.
The second big difference (in the UK at least) comes from section 75 of the consumer credit act. It states that any purchase between £100 and £30,000 must be covered by the credit card issuer in the event of a problem, even if you only paid £100 of a £10,000 purchase with your credit card. That means when you’re booking a holiday, and they have some strange (thankfully now much rarer) policy of levying a 3% fee for using a credit card, you can pay £100 on your credit card, the rest on your free-to-use debit card, and still be 100% protected by the credit card issuer. Free peace of mind, and some cashback while you’re at it!
Linking to the above, another big benefit is the security of your card. When you pay using a debit card, you’re handing over the keys to your entire savings (unless you have a proxy account, which I’ll cover in another post). This isn’t so bad in countries with chip & pin (though you’re still susceptible to online fraud if someone copies the details of your card), but is a huge problem in the USA. So instead of trusting each and every person you hand your card over to, simply hand over a credit card. If it gets skimmed or copied, you simply notify the bank, they cancel and re-issue the card, reimburse you for the fraudulent transactions, and they go off in search of answers. Don’t get me wrong, it won’t be a pleasant experience, but it’s much better than having your entire savings wiped out.
Some other benefits
- There are often VISA or MasterCard promotions, especially when booking event tickets, that are exclusive to credit card holders
- While your purchases transition from money owed, to statement, to taken from your account, that money can be sitting earning you interest, instead of the card issuer
- Some cards come with benefits such as airport lounge access (but you should always weigh up any potential fees with the benefits you will receive – and the ones you actually use!)
Credit card recommendations
This is definitely a subject deserving of a bigger blog post, but I’ll give you my quick top picks:
- RBS / NatWest’s cashback credit card (0.5% cashback, £24 annual fee)
- Tandem’s credit card (0.5% cashback, no annual fee, make their money from your data)
In summary, credit cards have a huge amount of benefits, and are perfect for almost everyone. It’s all about using them in the right way, and being fully informed on how they work.