Making the Most of the (Credit) Cards You’re Dealt
If you can’t pay off your cards in full, always pay off higher-interest-rate debt before lower-interest-rate debt.
Managing debt responsibly will do more for your credit rating than cutting up your cards.
Used responsibly, balance transfers, 0% financing and HELOCs can be smart financing tools. Just know which ones can trigger a credit alert.
When it comes to financial well-being and responsible credit management, few tools are as accessible and versatile as the credit card. From facilitating everyday transactions to building credit, and even offering rewards, they have become indispensable in modern financial life. However, to truly make the most of the credit cards you're dealt, it requires more than just signing up and swiping. It is important that you understand how to leverage them to your advantage, minimize pitfalls, and navigate the financial landscape with confidence. Whether you're a seasoned cardholder or just starting your credit journey, here are a few strategies to play your cards right and reap the rewards they offer.
0% APR credit cards typically offer 0% interest on new purchases for the first 15 to 21 months and then require you to pay standard card rates of 16% to 28%. The advantage is not having to pay the crazy high-interest rates for the first year or two that you have the card. These types of cards require discipline; they’re not something you want to rely on long-term. Use them only when making big discretionary purchases (my case, wedding planning) and be sure to pay off the balance aggressively before the interest period starts. It’s not enough just to pay the minimum. Also, there’s usually a one-time balance transfer fee, typically 3% to 5%. That’s how banks make their money on “zero percent” cards.
0% financing plans can also be useful for big discretionary purchases such as a new vehicle, new windows for your home, or major appliances. Also known as “interest-free” loans or “no-interest” loans, retailers and dealerships incentivize consumers with interest-free financing to help move inventory. Sounds great, but not everyone can qualify. Car & Driver says most dealers require a 740 or better credit score and you may have to provide income verification and a clean personal balance sheet. You might also have a shorter repayment period (say three years vs. the usual five to seven years) and dealers may try hard to add in fees for special features, maintenance, insurance, or extended warranties. The same goes for 0% financing on major appliances and other big-ticket items.
Balance transfer. Here you consolidate balances from your other high-interest cards and bundle them into a single low-interest rate card. As with 0% APR cards, there’s usually a 3% to 5% initial fee on the amount you transfer and then you get an interest-free introductory period of typically 6 to 18 months. This will greatly reduce your interest payments for the time being. Just know that balance transfers can trigger an inquiry or hit on your credit score and eventually the very low introductory rate will reset once the introductory period ends to the standard credit card rate--often north of 20%. So, you want to start paying down the balance more aggressively well before that reset date. If you don’t have any major purchases planned for the foreseeable future and won’t be applying for a mortgage or other loan, then a balance transfer may make sense. Again, that’s the tradeoff we work through with our clients – saving big on interest payments versus lowering your credit score. Before signing up for a 0% card or 0% financing program, be sure to check if there is a pre-payment penalty on the balance of the loan.
Home Equity Line of Credit (HELOC). For clients who are homeowners with a fair amount of equity built up, a HELOC can accomplish many of the things that 0% financing can do, except you get to set your own repayment terms on the outstanding balance. Pay down more aggressively when your cash flow is strong and pay less when cash is tight. Until the Fed started raising interest rates aggressively about 18 months ago, interest on HELOCs was in the 2% to 5% range which made them very attractive. Now that rates are in the 8%-plus range, the calculus has changed.
For some clients, we do detailed budget and cash flow planning that involves a HELOC to finance substantial home renovations or other big-ticket purchases, whether paying from cash flow or other sources or modifying their retirement savings. It’s all part of our holistic planning approach.
Cash back and rewards cards. I’ve been using cash-back cards since I was 18 and they’re as straightforward as it gets. Typically, you earn credits anywhere from 1% to 5% of your spending on certain categories such as gasoline, groceries, dining, office supplies, etc. As long as you’re paying off the balance every month, cash-back cards can save you money. Just know they sometimes have annual fees and often charge a higher monthly interest rate on unpaid balances than conventional cards do.
The travel and hotel rewards cards are trickier. Some clients swear by them, but others complain about the higher-than-average annual fees (and interest rates) and constantly running into blackout periods when they want to redeem points for hotel and air travel. They can also find themselves locked into a small number of participating hotels and airlines when it comes to accumulating points. Reach out at any time to discuss your particular travel needs and situation.
Bottom line: Whenever possible, pay off your credit cards in full every month. By showing the rating agencies you can manage debt responsibly, you’ll build up a higher score than if you have no credit card usage at all. That said, we sometimes have to carry a balance for emergencies, medical issues, or a one-time discretionary purchase. That’s part of life. Just don’t get yourself into a hole in which you’re just paying off the minimum. By paying only interest you’ll end up paying two to three times more on your spending than by paying off the balance in full. Finally, if you have multiple credit card balances and other loans outstanding, always pay off the higher interest rate balances first. I’ve seen people use their bonus to make extra payments on their mortgage, while only making the minimum payment on their $20,000 credit card balance. Why pay off a 3% loan early and only the minimum on a 21% loan? That’s not managing the good debt vs. bad debt equation well.
If you or a family member has concerns about credit limits, credit history, or financing major purchases, reach out at any time. I’m going through it myself right now during my engagement and would be happy to assist.
BRENDEN LEESE, CFP® is an Associate Wealth Advisor at Novi Wealth Partners