Let’s be honest: We make a lot of mistakes with credit cards.
I like to assume that most people don’t start drowning in high-interest credit card debt on purpose. We don’t choose to fork over billions to credit card companies every year because we feel bad that their execs’ planes are getting a little old.
But we do.
As you hopefully know by now, the overarching mistake that leads to all this debt is using credit cards to spend money we don’t have. But again, many people don’t realize this is happening as they swipe their cards. And one dangerous credit card mistake makes this far easier to do. Do you make it?
Do you fool yourself about the value of credit card rewards?
Cash-back and rewards credit cards can put a few hundred extra dollars into savvy spenders’ pockets every year. But the credit card banks don’t offer rewards to pay off customers who will never make the banks money; they offer rewards to bait customers who will pay the banks handsomely. Could that be you? Here are a few reasons it might be:
1. You Love to Shop
For many, big purchases get a little bit easier if you know that you’ll earn a one, two, or three percent “rebate” from credit card rewards. Whether you get a thrill from shopping and credit card rewards push you to make impulse decisions or you’re a coupon and discount shopper who sees rewards points as a “value-add” or “something for nothing” because you would buy the item anyway, watch out.
You may be walking into stores with a devil on your shoulder saying:
Don’t be afraid to shop. You have a cash-back credit card. The price charged on your receipt isn’t really what you’re paying.
Simply put, knowing that you are being “rewarded” can be a powerful and dangerous incentive for spending.
2. You Carry a Balance
Obviously, carrying a credit card balance is never a good idea, no matter what kind of card you have. As you know, credit card companies charge interest on any positive balance during a billing cycle. The higher the interest rate, the more an unpaid balance costs you—even if it’s just for a month or two.
Now, compare two credit cards: one with rewards and a comparable card without rewards. What do you notice? Most often, rewards cards have significant higher interest rates.
And it doesn’t take much debt to outweigh even the most lucrative rewards points.
Let’s take a look a couple of examples. For both, let’s assume that you spend $500 a month on your credit card and also carry an old balance of $1,000. Every month, you pay $550 towards the card (all of your new purchases plus a token amount towards the old balance).
Over a year, with a credit card that pays a standard one percent cash rewards and has a 16.99 percent APR, you’ll pay about $227 in interest and earn $60 in rewards for a net cost of $167. If you did the same with a credit card that has no rewards but a lower 10.99 percent APR, you would pay $142 in interest—a savings of $25.
Now let’s assume you have a $5,000 balance, still spend $500 a month, but pay back $600 a month (your new purchases plus $100 towards interest and the old balance).
With the 10.99 percent no-rewards card, you’d pay about $574 in interest annually. Ouch. But look that that rewards card. You would pay about $913 in interest over the year. Even if the rewards card paid you three percent cash back (less common, but not unheard of), you would still have a net loss of $733 and could save $159 with the lower APR non-rewards card.
Obviously, the bigger your balance, the longer you carry it, and the less you spend in new purchases, the more a lower APR card helps. But the bottom line is any interest you pay quickly cuts into credit card rewards.
3. You Spend Too Little
Have you avoided joining the millions Americans currently swimming in credit card debt? Congrats: you’re living within your means. And unless you’re super-rich, that means you probably don’t spend all that much.
Unfortunately, by spending little, you’ll never unlock rewards cards’ potential.
Some of the most generous rewards cards, like Amex Blue Cash, only dial up their rewards percentage after you meet an annual spending minimum. And most cards have minimum rewards levels that cardholders must meet before they can redeem cash or points rewards. Sometimes rewards may even expire.
If you spend $5,000 a year on your card, a one percent reward is worth $50. Sure, 50 clams is nothing to scoff at, but is it worth going with a card that may have less favorable rates and fees? Only you can decide.
4. You Have So-So Credit
If you have bad credit, you want to improve it. Two things that will not improve your credit are applying for several credit cards and, of course, taking on any new debt.
Especially in the post-2008 credit world, rewards cards require applicants to have good to excellent credit.
Apply for a card with only marginal credit, and you may be declined, which isn’t great for your credit. Even if you get the card, perhaps it shouldn’t be a rewards card. To improve your credit, you want to avoid any temptation to go into debt. If you do need a credit card to start building or reestablishing credit, stick to the most basic card with the lowest APR that you can get approved for. Period.
Would you agree with these reasons to not get a rewards-based credit card? Did any of these points apply to you and you avoided a difficult financial situation? Are there any other reasons that someone shouldn’t get a rewards card?
About the Author: Simon is a recent college grad living in Brooklyn. He writes for an interest rate-tracking Website and maintains his own personal finance blog, the Realm of Prosperity.
Editor’s Note: Thanks to Darwin’s Finance for hosting this week’s Carnival of Personal Finance!