Credit cards are really useful and convenient now days, but it’s so easy to fall into debt and your finances can quickly spiral out of control. Let’s explore the credit cards pros and cons and see if it’s something that will work for you.
Listen to me chat about credit cards pros and cons on Cape Talk Radio.
TLDR : If you’re really good at managing your money and controlling your expenses then a credit card could be a good thing. However, if you have little self-control then rather don’t even consider a credit card.
Before looking at the pros and cons of credit cards, let’s first look at the costs involved if you buy things on credit.
Credit Card Costs
Everything costs money, so a good start to investigating credit cards is looking at all the fees applicable. Most banks and financial institutions will charge a myriad of charges including an annual card fee (sometimes a monthly fee), a lost card fee, monthly membership fee, service fees and possibly even loyalty program fees.
All these costs are not always obvious upfront and will require some reading up. However, using my own card as an example, here are the fees I pay on my Discovery Credit Card (in 2018)
- Annual Discovery Miles (loyalty program) fee R435.79
- Monthly service fee R43.38
- Monthly credit fee R16.14
- Replacement fee for lost card R166.45
Thus, on a month to month basis I pay R95.86 for the privilege of using my credit card. Obviously other banks have their own charges so why not have a look right now at what you are paying. And if you have multiple credit cards then you are paying multiple fees. Calculating the annual costs involved in having a credit card can be quite a shocking calculation! So based purely on the fees, is it worth keeping your card(s)?
Other fees to take into account are cash withdrawals, transfers, fuel transactions etc and these fees may or may not be applicable to you depending on how you use your card.
Cost of credit – or cost of DEBT
In addition to the monthly costs are also interest charges on your purchases. This depends a lot on how you manage your account as you can get away with paying no interest at all as we will see later on in the post.
The way your account works and how interest is applied is rather complex and I sometimes think that companies purposefully hide the true details. I spent over 10 minutes looking to see what the interest rate is for when I owe money on my credit card and I eventually found it on my statement. The website and marketing material obviously show all the benefits and good things but you need to search a bit to find the interest rate details.
The interest is 24.3% which is really high! In fact it’s probably the highest interest rate you will find when it comes to borrowing money. And all credit card companies offer similar non-negotiable rates.
So if you purchase something for R1,000 but pay it off over 6 months you will end up paying R1,127.82 (give or take). This is not an exact calculation as it does not take the interest-free period into account nor the monthly fees. But let’s say it’s approximately R127.82 in interest that you are paying. It may not sound like much but imagine you spend R12,000 and end up paying it off over 8 months. In that case you would pay R2,087.50 in interest! That is a lot of money especially when you consider that most credit card users have no idea what they are spending month to month and the interest portion just grows and grows!
Do the interest calculations yourself
Have a look at calculating the Future Value of an investment to see how to do the interest calculation yourself. The Excel Formula FV can also show the interest you will pay on your debt. Interest is the same thing whether it’s interest you are earning or paying – the value is the same.
Why using a credit card is a bad idea
It’s obvious from the sections above on fees and interest that credit cards are expensive! Generally speaking a debit card is much cheaper and many bank accounts offer a linked debit card which doubles-up as an ATM withdrawal card with minimal fees. The advantage of this is that you can not spend more than what you have in your account and thus no interest will be charged and you cannot get yourself into debt.
If you struggle with self-control when it comes to shopping then credit cards are very dangerous! Spending money is just too easy! This counts for any store cards too; the ones that allow you to spend now and pay later. If you can’t control your spending then rather cancel your credit card as well as cancel your store cards. You don’t ever need to be tempted with a credit card as it is just bad news!
If you don’t specifically need the credit you are being offered on a credit card, rather don’t have one! And really question yourself why you would want more than one credit card!
When using a credit card could be a good thing
There are instances where it does make sense to use a credit card and it can be a good thing. I’ll share my own circumstances to help you understand.
So why is a credit card good?
Firstly, it’s convenient! It’s no more convenient than a debit card in that you can use both types of cards anywhere. The difference obviously is that you can use money that you don’t necessarily have. What I mean is that if you have no money in your bank account you can still buy things with your credit card (although you’ll be in debt).
However, if you have money in your bank account and use your credit card then you can earn interest in your bank account during the interest-free period on your credit card. Usually you have 55-days interest free on your card but there are some complicated rules so I do my calculations on 30 days. Thus, if I spend money on my credit card but actually have the cash in my account, I calculate the interest I earn in my bank account for a 1 month period. It’s not exact, but it explains a concept.
Earn interest on your cash
If I spend R1,000 on my card in a month whilst I actually have the cash in my bank, I will earn R4.04 interest in my bank account (my Capitec account earns 4.85% interest). And if I use my home loan as a savings account, with at an interest rate of 10.25%, I will earn R8.54.
Neither of those amounts are worth writing home about. However, if I spend R5,000 on my card and have the cash in my bank account I would earn R20.21 in my Capitec account or R42.71 in my home loan account. And if I spend R12,000 on my credit card and have the cash in my account I would earn R48.50 in my Capitec account or R102.50 in my home loan account.
Thus, if I spend R12,000 or more on my credit card in a month when I actually have the cash in my account, I can earn a little more in interest than what my credit card fees are and get the convenience of using my card.
This only works if you:
- reach a spending threshold per month
- actually have the money in a high earning account (or investment)
- pay the full amount off on your credit card at the end of each billing cycle
- use an app to manage your money (see how I use YNAB in South Africa)
Reward programs
In my case I also receive reward points and cash back on card spending which actually equates to R300 – R400 per month. This is because I only have 1 credit card and I only belong to one loyalty program and I use my card for everything!
I feel that you should only ever join one loyalty program and do everything you can to max out your rewards. Each program has a membership card, an app, rules and admin. I enjoy saving money but I don’t enjoy having to carry around a wallet full of cards and to check all my apps for specials and to go through all the admin of using my points at the right time to earn something-or-other. Do one loyalty program and do it well!
So is a credit card good or bad?
If you have good self-control and manage your money with a monthly budget it can be useful and convenient to use a credit card. You should however try get into the cycle of only spending money that you actually have. Cash flow is super important and having the money in your bank account means that you can earn interest on it while you spend on your credit card. You must be disciplined though.
A credit card is also very useful for emergencies as you never know when you may need money right away. Again your should have money saved in your emergency fund, but you can always use your credit card for the immediate transaction and move money between accounts at a later date.
Look at the credit cards pros and cons. It’s easy to work out for yourself what is better as the calculations really don’t need to be over complicated.
Work out what’s best for you and then stick to it!
Indeed. Credit card is really useful. Thank for sharing such meaningful post.😊
Unfortunately, having good credit is everything if you live in North America. The last thing you can do is have bad credit rating and the bank would not give you a credit card. Very detailed analysis Brendan, keep up the good work!
-VIncent
http://thevincentle.com/
Just opened my first credit card this week, very timely for me to read this! This is helpful context and an important reminder about self-control.
They can be useful. But also very tempting to spend what you don’t have! Great post.
I think they are useful but the balance should be paid off at the end of every month. You don’t want to pay interest on any balance.
Yea I agree! You need to pay the full balance to prevent getting yourself into debt!
If you are disciplined and have self controls then credit card use is a blessing.
Just as you detailed there are definitely pro’s and con’s and everyone must make that personal decision on what is best for them.
Personally, I love my credit cards. They basically allow me to automate almost all my finances. I have never paid any credit card fees and pay them off in full at the end of each month. The accumulated points made December a “free” month for us.
That’s great! If you can ‘work the system’ and win at it then it’s really worth it
Don’t know if I would call it “working the system” We never got cards just for points and then cancel them. We used one card consistently with another as a backup only. We have had those same cards for over a decade.