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Advantages Of Using Credit

Advantages Of Using Credit

Advantages Of Using Credit

Introduction

“Americans are more concerned about technological threats than they are about physical ones, like war or terrorism”. While credit card fraud remains one of the top concerns for Banks and financial institutions, there are sufficient credit monitoring services and tools available out there that people can take advantage of at a much cheaper cost and get a peace of mind. What many people don’t realize is by not using credit, they are not only missing out on valuable cash that they can potentially get back, but also their credit history not building up and score not improving due to the lack of using any form of credit. While using various forms of credit does expose one to identity theft to some extent, not using credit has some serious drawbacks per se.

 

Analysis

The advantages of using a credit card can be divided into various categories:

 

1) Cash-back

There are credit cards available in the market that offer anywhere from 1% to 5% cash-back on everyday purchases. While most of the banks limit these cash-backs per month or quarter, there are offers and deals available that do not have any such restrictions. One example of a high cash back credit card is Blue Cash card from American Express. This card offers 5% unlimited cash-back on Supermarkets, Drug Stores and Gas stations. Though there are news that American Express has now put a $50,000 spend limit for the 5% cash-back for new cardholders. Below is an illustration of the cash-back a typical household can earn using this card on these three categories:

Category Amount Cash-back % Cash-back Amount
Supermarkets/Grocery $800 5% $40
Drug Stores $80 5% $4
Gas Stations $200 5% $10
Total $1,080 5% $54

 

Another example of a credit card offering 2% unlimited cash-back on everything is Fidelity Rewards Visa Signature Card. This card does not put limitation for only the purchases at supermarkets, drug stores and gas stations.

 

Another recent lucrative cash-back deal was offered by Discover. Discover usually has 1% unlimited cash back on everything, and 5% cash-back on rotating categories. Following is the expected calendar for the rotating categories for discover for 2016:

 

Quarter Category
Jan – March Gas & Ground Transportation
April – June Restaurant & Movies
July – Sept Home Improvement & Amazon.com
Oct – Dec Amazon.com & more

 

In addition to this, Discover offered a program called “Double Cash-back” for new and existing cardholders. However, the program was offered for limited time for existing cardholders. As part of this program, Discover would double the cash-back earned by the cardholders in the next 12 months. This means what regularly was 1% would become 2%, and what regularly was 5% would become 10%. Getting a 10% cash-back on things like Gas stations and Amazon is a big deal, since the merchants are only getting a thin profit margin on those items and it is hard to get discounts year around on those items. Moreover, Discover has an online shopping portal called “Discover Deals”. People can usually get anywhere from 5% to 15% cash-back on stores like Macy’s, Apple, Kohl’s, BestBuy etc. It is worth keeping in mind that all even these 5% to 15% cash-backs will also be doubled at the end of year, since Discover did not put any restrictions on them in their terms & conditions. Getting 30% cash-back on stores like Macy’s is a big deal, since this is completely separate and in addition to what you will get using, say, Macy’s own sales (such as Black Friday) and their coupons/discount codes.

 

With the recent online competitive landscapes, companies like Amazon and Costco are not offering prices more competitive than stores like Walmart & Target. People are now even using websites like Amazon for their everyday purchases such as appliances, electronics, groceries, books, clothes, toys, furniture etc.

 

2) Sign-up bonuses

Customers are valuable for banks and financial institutions. They not only pay interests on products such as loans, mortgages and credit cards, but also pay fixed fees for cards that come with an annual fee. To earn their business, banks usually offer sign up bonuses that range anywhere from $50 to $500 when the customer spends a specific amount within a specified period. This can be in the form of cash, but often times are in the form of frequent flier miles. An example is Citibank offering 50,000 American Airline miles upon completing a spending requirement. This credit card does not have an annual fee for the first year. If one American Airline mile is valued at 1 cent, it amounts to $500 in cash equivalence. Some people are afraid of the initial spending that is required in order to get the sign up bonuses. These spending requirements can be anywhere from $500 to $5,000. Although it may seem high at first, there are smart ways to complete the spending requirements. One example is to pay the monthly rent. Plastiq is an online company that lets users pay their monthly rent using a credit card. They charge a fee such as 1.5% of the amount. Assuming the customer uses Fidelity Visa card for this purpose, that earns 2% unlimited cash-back on everything, it amounts to a net cash-back of 0.5% after fee.

Item Amount Cash-back % Cash-back amount
Rent $1,000 0.5% $5

 

This not only helps the customer meet the spending requirement to earn the sign up bonus, but also earns the cash-back. Most people already assume things like rent, mortgage, insurance etc. could not be paid using a credit card. However, the example above suggests not only otherwise, but is also a positive cash flow for the customer.

 

Smart customers can often accumulate hundreds of thousands of airline and hotel points, and can travel for free at various destinations. An example, though a little extreme, was recently featured by CNN about a homeless man who travels the world in first class for free.

 

“Schlappig is a “Hobbyist,” as those in the game call it — a professional traveler with an almost obsessive attention to fine print, who uses a mixture of frequent flyer miles and credit card reward points, to zoom around the globe for a fraction of the cost.”

 

3) 0% Interest

People who have good credit are sent offers such as 0% interest on purchases and balance transfers for anywhere from 1 to 2 years. It is basically a kind of interst free loan offered by the Bank. People who are in high interest debt can take advantage of these offers to get rid of monthly interest. Assuming a person having $20,000 credit card debt at an interest rate of 20%, uses one of these offers to transfer the balance or payoff the high interest credit card, the savings can be calculate as follows:

Interest Rate Principal Period Amount
20% $20,000 1 Year $4,000

 

$4,000 is an immense saving for someone in high interest credit card debt.

 

Even if a person does not have debt, the 0% interest offers can be used to start off a business or to even simply invest in a high yield instrument such as mutual funds, junk bonds, U.S. treasuries etc.

 

4) Credit history/score build up

People who have never used any form of credit would not have a credit score. In order for the credit score to be calculated, some form of credit needs to exist. It can be an auto loan, a mortgage or even a credit card. It doesn’t matter how much savings a person has, not having some form of credit would prevent the credit score to be generated. Someone having a long history of good credit usage and management would have a score in good or even excellent range. The following graph represents what FICO score (used by over 70% of lenders) is comprised of:

 

People having good to excellent credit scores will get favorable interest rates compared to people who don’t. This can range anywhere from 0.25% to 1% reduced interest rates on various loan products such as mortgages and auto loans. The amount of savings by getting a 0.5% lower interest rate is illustrated below:

Product Principal Period Interest Rate Saved % Interest Saving – Amount
Mortgage $200,000 30 years 0.5% $21,000
Auto Loan $20,000 5 years 0.5% $270
Total $21,270

 

Conclusion:

To some extent, people are rightly afraid of credit. It can be highly dangerous for someone who isn’t good at managing their personal finance, or who take bad advantage of the credit available to them, such as extravagent and unncessary shopping and spending. However, if rightly used, credit can be very advantageous to people in terms of savings. In the current times of high healthcare costs, expensive college tuitions and volatile equity and housing market, the potential savings by having a good credit score and proper usage and management of credit cards can have colossal impacts on one’s personal finance.

 

Works Cited

Sheena McKenzie. “Meet the ‘homeless man’ who flies the world first class”.

CNN. 17 December 2015. Web. 27 March 2016.

 

Libby Kane. “Americans Are More Afraid Of Credit Card Fraud Than Of Terrorism”

Business Insider. 25 May 2014. Web. 27 March 2016.

 

How my FICO Scores are calculated

myFICO. 2014. Web. 27 March 2016.

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