The two sides of the credit card

The credit card has two sides – one smooth, leading to a state of financial bliss; the other rough, leading to a state of financial misery. Bliss or misery is determined not by the terms of the card, nor the price of goods and services, nor the attitudes of financial institutions, but by the financial behaviours of the card user.

Credit cards have certain common features. Here are some. Every card is issued by a commercial bank, credit union or building society and runs on a network – Visa, Mastercard, for example – that determines where it is accepted. Every card has a credit limit – a pre-approved maximum the user can borrow at any time, and spending above this amount is usually declined, unless the user has over-limit protection. Every credit card has revolving credit and users can pay in full or carry a balance month to month, with unpaid balances attracting interest.

Every credit card has a billing cycle and statement: purchases are grouped into monthly cycles, and are shown on a statement, which shows all transactions for that cycle, the total amount due, the minimum due and the payment due date. Every card has an interest-free grace period for amounts paid in full by the due date. Every card has an annual percentage rate for purchases, cash advances, and some fees.

There are also some common features which are not universal. Among them are rewards programmes like cashback, points, or miles, travel insurance, and purchase protection.

One significant benefit of credit cards is their convenience, for they allow cashless payment for a wide range of bills – groceries, utilities, travel, and a wide range of services. Herein is where the determination between bliss and misery is made. Users who use their cards responsibly – spending within their ability to pay and paying in full and on time – are in a position to enjoy bliss.

Users who use the interest-free grace period well are able to enjoy significant benefits – and the interest-free period can be significant. Let us say that the billing period of a card runs from the sixth of one month to the fifth of another, and that the payment date is the 30th of each month. The cardholder who makes card purchases up to the fifth of September has up to September 30 to pay. That is 25 days interest-free for transactions on September 5. Then the cardholder uses it on September 6, so payment becomes due on October 30 – 54 days interest-free. Only the card user who pays in full and on time derives this benefit – no such luck for the cardholder who does not or cannot do so.

On the contrary, the latter cardholder must pay interest and at a high effective annual percentage rate – hovering close to 50 per cent in some cases. This applies even if the required minimum payment is made. Paying the minimum only allows the user to continue to use the card, considering that interest is charged on the average daily balance.

So one cardholder saves and the other pays. One builds a good credit score, the other, a bad credit score. This holds implications for borrowing in general.

Beyond that, cardholders who pay off their balances derive benefits such as cashback, which do not apply to unpaid balances, enabling them to have more spending power from those savings.

Additionally, although all cardholders pay annual fees, those who do not manage their cards well may incur late-payment fees and other penalties. This is why it is important not to max out the card.

A significant consequence of overspending is the debt spiral it may unleash as interest compounds, making it difficult to escape without a disciplined pay-off plan. Overspending also reduces the ability to use the credit card for emergency spending when unexpected expenses arise: it is best done when there is a viable way to pay such debts in the short term.

The issuing of statements for each payment cycle is an extremely useful tool. It can be used effectively to see how money is being spent and to re-organise priorities, including what to reduce and what to eliminate. Card users who utilise this can enhance their budgeting and lift their chances of enjoying long-term financial bliss.

Two people can each have the same type of credit card from the same issuer, and the same credit limit, interest rate and rewards. But the one who pays in full and on time, tracks spending, spends on high-priority items, and avoids impulse buying experiences a state of financial well-being and enjoys financial bliss. The one who spends emotionally and is not able to pay fully slides into distress – the difference is that the credit card is a convenience tool to one, and a high-cost liability to the other.

Oran A Hall, author of Understanding Investments and principal author of The Handbook of Personal Financial Planning, offers personal financial planning advice and counsel. Email: finviser.jm@gmail.com