Credit cards don’t come with the warning: “Frequent use can be dangerous!”
And it shouldn’t, you say?
Well, fair enough, since only adults are issued credit cards, and they should do their due diligence before acquiring and using easy money.
Some credit card features might need a warning though, lest greedy consumers are themselves consumed. Afterall, misinformation might follow easy money, but diligent research often does not. Madoff’s ponzi scheme, for example, succeed partially because investors had not done their homework. According to news reports, some invested because a trusted source convinced them to, and without doing any background checks.
Similarly, an acquaintance tried to convince me to pay for everything with credit, to gain the rewards — particularly cash back.
“Are you crazy,” he asked me one day as I paid for an item? “Why don’t you use your credit card to pay for that?”
“Um….because I have the cash.”
“But if you use your credit card, you could be making money,” he insisted. “They pay you like 1 per cent cash back when you use your card to pay for things — groceries, gas…everything! And at the end of the year they send you a check.”
I’d heard about those cards, and ignored them, being too lazy to really look into it and answer one nagging question: why would a for-profit company give away cash like Santa Claus at the end of the year, seemingly without benefit to itself? Had there been a sea change in commercial business rules, or the business raison d’être?
According to my acquaintance, I was misguided, and the benefits real; What he overlooked was how easy it would be for me to spend myself into a trap with such a card; but that’s not his responsibility, right? It’s mine.
As a result, I started looking into cash back credit cards, also known as rewards cards (because rewards go beyond cash and may include points etc.).
How Much Can You Really Afford to Spend for Your Rewards?
There are many web sites tooting the easy money angle, and others that help you card-compare for the highest benefits. FrugalTrader, on his web site Million Dollar Journey compares various cards, thoughtfully using his own spending habits to decide which is best for him. On the other hand, the Financial Consumer Agency of Canada (FCAC) provides risk and benefit information, along with comparison tools, for all types of credit cards.
Things started coming together when I repeatedly read that cash back credit cards are best for those who pay their monthly credit card balances in full. So while these cards promote a spend more, earn more rewards message; the strategy is best employed by the rich. Without being rich, how else could you spend thousands every month and pay it off within the no interest charge time frame? FrugalTrader, for example, states that he spends approximately $30,000 yearly on his credit card, and at the time of his analysis, expected to get between $250 and $340 in cash back, depending on the chosen card. I could not afford to spend that much, and imagine that neither can others with modest incomes.
Still, what if you saved that $30,000 which you would spend on credit, by saving $2,500 per month for a year? At 1.35 per cent, ING Direct’s current savings rate approximates the rewards card rates. (You can substitute alternative no-fee banks and rates.) So, based on that rate, savings in a tax free savings account (TFSA), would total $30,220.28 at the end of one year. That $220.28 in interest is comparable to the cash back amounts, but better, because you have that $30,000 as well, and your interest won’t be taxed. So if you didn’t have to spend that $30,000, and your goal is really to save money, then it might be worthwhile investigating the alternatives.
On creditcardassist.com they explain that the higher annual percentage rate (APR), which is charged on your unpaid balance, effectively offsets the cash reward you’re expecting. So if you carry a balance from one month to the next, the company essentially reclaims the rewards through higher interest charges. Meanwhile, some card companies astutely charge an annual fee once your application for the rewards card is approved; however, equating the reward with that fee makes the scheme less appealing, for why not just keep your money in the first place and avoid the risks? Interest can be earned elsewhere.
Add to that the fact that credit cards, according to the FCAC, can “cost much more than other forms of credit, such as a line of credit or a personal loan.” It’s then easier to see how the little rectangles can help you incur more debt than you can handle. And once in that hole, problems tend to compound, possibly affecting your credit rating.
Merchant Fees — What’s 2%?
Earlier this month Dana Flavelle reported in the Toronto Star that independent grocers did not support credit card promotions that encouraged purchasing groceries on credit, and I was a little surprised to read one comment that suggested it’s about time grocers got back some of their own medicine.
According to the article, credit card purchases can cost grocers up to two per cent of the purchase amount, compared to a roughly seven-cent flat fee for debit transactions.
That two per cent may sound piddling, but in an article for the Ottawa Citizen, Mark Anderson points out that it adds up to billions ($4.5 billion annually) for credit card companies.
Those who feel fleeced after doing their weekly grocery shopping are understandably unsympathetic to the griping grocers, but would do well to consider the truth in what they’re saying: purchasing essentials on credit is one way to loose track of your finances.
Even the Canadian Bankers Association suggests that consumers stick to their financial plan and avoid unplanned spending because credit comes at a cost.
Rewards cards have a cost. Essentially a marketing strategy, it’s designed to entice consumers to spend more and ensure retailers have to offer credit cards as a payment option, while credit card companies gain billions from both sources. Possibly the most lucrative source being consumers who do not eliminate their outstanding balances monthly, and therefore pay high interest rates.
Unhappy with the increased expense, retailers will inevitably pass those expenses to consumers in the form of higher prices. Therefore, if you’re not paying for that reward up front, trust that you’re paying in the back-end, as credit card companies take a portion of the merchants’ fees to reward you.
Beware of Card “Terms and Conditions”
Some rewards cards payout cash based on complicated formulas; others, with a simple annual check based on the amount you spent for the year. But the people at consumerreports.org caution that there are other factors to watch for.
For example, cardholder agreements often have fine print or “terms and conditions” that state that rates are subject to change at anytime; and so does the cash-back agreement. So they advise being alert and reading your monthly statements throughly, including any inserts, to stay abreast of changes.
Late payment fees, short grace periods and high default rates are usually in that fine print. Also note that balance transfers and cash advances do not contribute to higher rewards, since the rewards only apply to new purchases.
Furthermore, in some cases you have to request your reward in order to get it; It’s not automatic and can be lost. Now that would be sad!
Living in a Credit Worthy Nation
The Canadian Bankers Association, on their web site, note that a recent survey showed that the majority of Canadians managed their credit well, with 70 per cent of Canadians paying off their credit cards fully each month. In comparison less than half of U.S. residents did the same.
Nevertheless, simply spending on credit to gain rewards might be risky, if by doing so, you forget to budget for that rainy day when you won’t be able to pay off the balance in full, before interest charges accrue. Especially in the current economic conditions, a downward cycle can begin quickly. Job loss comes to mind, given constantly increasing unemployment rates, and management’s messages within the company where I work.
Thanks to the CBA, FCAC and others who’ve helped reinforce my initial thoughts, I will forgo the temptation of a reward card. Knowing myself, and preparing for the occasional oversight, I’ll play it safe and live within my means. Anyway, the credit card I choose should be based on my financial situation, and not on any one factor, such as cash back.
Those cards seem more likely to stir up greed rather than provide rewards, for there is no change in the for-profit business credo.
- Make a budget for yourself and stick to it. Make sure that you know what is coming in and what is going out. That way you will avoid nasty surprises.
- Avoid impulse buying. If you had to pay in cold, hard cash, would you be making this purchase?
- Be knowledgeable about the cost of credit. Are you using the right type for your purpose? Are you using a more expensive form of credit than necessary?
- Be sensible about the number of credit cards you use. How many do you really need? Are you using them simply because you have them?