In and of itself, credit is a neutral financial vehicle. Credit doesn't have a moral position. Credit isn't out to get you. Nor is credit the answer to all of your financial problems. Credit may SEEM as though it is working for or against you, but that is more a product of the financial situation that surrounds the credit than the credit itself. And here's the trick you should remember - the financial situation that surrounds the credit offering is what makes credit good or bad.
If you could borrow money at 8% and make a guaranteed 44% on that money, how much should you borrow? As much as you can! Under this circumstance, all credit is good credit. No matter how poor you may have been before this opportunity presented itself to you, you should stretch your resources to the max and expand, expand, expand.
Of course there is no 100%, fully guaranteed 44% investment anywhere in the world, at least not one that pays on a consistent schedule. If this existed, bankers would be knocking down your door to give you billions of dollars in credit and split the profits with you. Here's something you should know: Bankers do knock down the doors of certain investors to give them credit. Why? Even though there is no such thing as a guaranteed 44% investment, bankers know that proven financial vets are the closest thing to a guarantee, and they are willing to bet on those investors.
When you begin to recognize how the financial situation around credit makes it good or bad, your bank will begin to show you this kind of respect. You want to become one of the proven financial vets that bankers search for.
Good credit is credit that is being used towards building an asset. For instance, using a credit card to build a garage or a bathroom on your home could be considered good credit, contingent upon the market conditions around your home value and your buy in price. Good credit may also include paying for online education to get a certification that will earn you more money. These situations are not fully guaranteed to pay off, but possible outcomes and general range of risk can be calculated. This is all you need to take out good credit - a truly informed educated guess that points to profitability within a time frame that is advantageous to you.
And what is bad credit?
Just about everything else!
The best financiers know that 95% of the profitability game is passing on 99% of possible deals. If you cannot make an educated guess that your credit card purchase will lead to profitability, then you are likely looking at a bad credit deal. This may include paying for consumer goods that you have the cash to pay for. Yes, you have the money to cover the purchase, but this can actually make you complacent. You are likely to stretch out the payments and incur pointless interest on the purchase.
This moves us nicely into the next step of making credit cards work for you - getting a great financial partner to back you.
You are probably familiar with the "rewards program" of the modern credit card industry. If you really want credit cards to work for you, it is time to master the rewards program. By proxy, you will also master your relationships with financial institutions.
In a highly competitive credit card industry, the best financial institutions are the ones with the leverage to offer advantageous rewards programs. Defining the "best" program is not a fully objective practice, however. Your lifestyle determines how you can best use credit cards to your advantage. For instance, there is no need for a Reward Miles program if you don't travel.
The major takeaway here, however, is that you must consider the timing on rewards, cash flow it creates for you and the non-cash rewards that you will receive. Cash back programs may seem like the best deals because you are actually getting currency back into your accounts. What you may be missing is that a discount on a selected product may save you more money than you receive back in the cashback program.
For instance, would you rather have $250 back in hard cash or a 10% discount on a trip to Machu Picchu that costs $5000? [Hint – if you take the 10% discount, you save $500.]
Again, however if you have no interest in Machu Picchu, or you do not have $4500 to spend on a trip, then the $250 may actually work to your benefit. As you can see, there is no hard and fast answer. You must determine your best results from your individual lifestyle.
Now – how do you choose a financial institution after you have assessed your lifestyle and the rewards programs that will work best for you?
Just because you see some great rewards now does not mean they will be there in six months if the bank that you choose is unstable (or greedy).
Your lifestyle may change as your financial situation matures, and you need a bank that can scale with you.
This will help to ensure the stability of the rewards programs that you choose. It will also help to ensure that you can actually use your rewards no matter where you are.
This is one of the most important concepts to master if you want to use credit cards to your advantage. The TIMING of your money is just as important, if not more important, than the amount you actually receive. This is the main reason that we love credit so much. If our light bill is due tomorrow but we have no cash on hand, credit gives us the cash flow to pay it without incurring late fees and the inconvenience of no lights.
The same concept works as you turn credit cards into a profitable financial vehicle for you. Look to your credit cards not to generate income for you, but to improve your cash flow so that you can generate income from your other financial vehicles. In general, user credit cards to conserve your cash for high-value investments that you can then use to pay off your cards before you incur too much interest.
An example: Let's say that you have an educational investment that will bring you a permanent $5,000 increase in your salary in a year. The certification school costs $3,000, and you have to pay it all upfront. You have $3,000 in your bank account, and you have credit cards that max out at $3,000 with a 10% interest rate.
Should you use your cash or your credit cards in this situation? You can pay off the tuition right now, interest free with your cash. Why wouldn't you just go ahead and take care of it?
The numbers look obvious if you think in the short term. But if you dig a little deeper, you will see that using your credit card is a good financial decision, even if you end up paying a bit more in interest. Let's take the deeper look.
First of all, consider your the other expenses you have in your life. If you use all of your current cash on tuition, what you going to do about food and rent? You always need a cash reserve in case of an unexpected accident so that you don't have to worry about getting kicked out of your living arrangement. You will also need good food if you plan to do all the homework for your certification class. It is best to use your cash on nutritious food rather than eating Ramen noodles every day suffering through your assignments.
You are also more likely to budget yourself if you are spending hard cash on a day-to-day basis. Using your cash on daily expenses automatically causes you to conserve. Forbes found that the average person spends around 100% more when using credit and when using cash.
Now, let's consider the interest you will pay. At the end of the year, you will incur $300 of total interest assuming a simple 10% APR on your credit cards. This means you will end up paying $3300 for certification class instead of the original $3000 tuition. However, you know with a degree of certainty that you will begin to make $5000 more per year after you receive your certification. This more than takes care of your interest payment, and gives you a much more comfortable lifestyle while you are going through the program. The intangible effects of studying while in a comfortable environment and with peace of mind are also worth much more than the $300 that you will pay in interest.
Do you have a financial institution that will help you work out these numbers? At Seacoast, we love helping people leverage their credit cards to achieve life goals like this.
You can and should use credit cards to improve your credit score. This does not mean that you get to spend tons of money on consumer goods with no profit motive. There are some rules to follow. If you follow them, you can expect to open your financial situation to the next level.
All banks, including us, want to see that you have a history of responsibly using credit before we expand your credit. The easiest way to gain this history is through unsecured credit cards. Take a look at the following best practices to get the most out of yours.
If you are not spending on your credit cards in a disciplined way, then none of the other tips will work for you. It is vitally important to understand the timeline of your spending as well as the volume of your spending. The only way to do this is through a proper accounting of how you're using your credit cards.
The average American has two credit cards for many reasons. If there is a problem with one card, the other can be immediately used. Having two cards also keeps you from trying to raise the limit too much on a single card. You will actually end up spending less on two cards.
Ideally, you should have cash reserves that match at least six months of your daily living expenses. At the very least, you should have enough cash to pay off the maximum amount on the credit cards that you hold. If an unexpected emergency stops you in your financial tracks, use the cash reserve to immediately pay off your credit cards. This way, you will not incur any unnecessary interest while you get back on your feet.
In order to increase your credit score most efficiently, you should spend no more than 30% of your available credit at any time. For instance, if your two credit cards hold a combined maximum of $5000 credit, you do not want to spend any more than $1500 at any one time. 30% is considered "responsible" by the credit rating agencies and will give you the best credit score, all else being equal.
Paying off your balance in full every month keeps you from incurring interest on your credit cards. Just as importantly, you are considered the most responsible kind of borrower. Your records reflect timely payment of all monies borrowed, meaning that banks will be able to trust you with larger amounts of money down the road.
Even if you have so-called "bad credit," try to stick with unsecured credit cards if you can. Secured credit cards may actually be considered detrimental to your credit because they raise red flags to the automated systems that generate approvals these days.
Going back to the tips in the section immediately above, make sure that you do business with a financial institution that is stable. This will keep you from having to experience fluctuating interest rates and the other problems that come with less stable businesses.
Keep in mind that credit cards can be used as a profitable financial vehicle. Once you really internalize this, you will never look at credit cards the same way again. The best practices above will ensure that you are always in control of your spending. Once you have become a responsible spender on credit cards, your financial world will open up. This is especially true if you have chosen the right financial partner to back your credit plays.
The importance of the financial institution behind your credit card cannot be overstated. You need a stable bank that is not looking to nickel and dime you out of your money just because you are using credit. There are different philosophies in the banking world about how to make money. When it comes to Seacoast, our reputation is based in helping people. You will never have to worry about needless hidden fees or constantly changing policies when you do business with us.
Once you decide to use credit cards in a way that will promote the rest of your financial life, give us a call. One of our dedicated credit experts will inform you of our products and give you the professional assistance that you need to make your plans work most efficiently.