The Best Way to Pay for What You Buy

The following is an excerpt from Securing Your Financial Future: Complete Personal Finance for Beginners courtesy of Rowman & Littlefield Publishers. All Rights Reserved.

In previous chapters we’ve talked about how to control your spending through budgeting and the importance of spending your money wisely by becoming a smart, well-informed consumer. But the one spending angle that we haven’t talked about yet is this: once you’ve decided to buy something, how do you pay? I mean this in the simplest, most literal sense: you’ve decided to buy something, the seller wants their money, and you’re willing to exchange money for whatever it is that they are selling—now what? Most of the time you have a choice, and the usual suspects are currency (bills and coins), check, debit card, or credit card. Does it matter which one you pick? Are there smart ways and not-so-smart ways to pay? Or does it simply not matter, since it all ends up coming out of your pocket in the end, one way or another?

Well, it does matter! This is a multiple-choice question that you’ll face dozens if not hundreds of times a year, and many thousands of times over the course of your financial life. As you might suspect, if there is one best way to pay for what you buy, then you should always use it, every time you have a choice. Well, there is one best way, and here is your rule:

Always use a credit card to pay, but never use credit.

What? Isn’t “using a credit card but not using credit” an oxymoron, like “jumbo shrimp” or “awfully nice”? No, it’s not—and here’s why: when you pay your monthly credit card bill, in full, before the balance is due, then you aren’t charged any interest. So your strategy is to use a credit card but to pay the monthly balance each and every month without fail. If you do this, then using a credit card is perfectly safe and offers some critical advantages over all the other ways that you can pay. (It’s even better if you arrange to have your complete credit card balance paid each month automatically; just be sure to examine every transaction during your budget cycle for fraudulent or inaccurate charges.) But if you don’t pay the monthly balance in full, on time, each and every month, then credit cards are extremely dangerous to your financial health. Because this point is so vitally important, I am going to restate the rule in a little bit longer form so that when you look back to refer to the rule, you won’t forget it:

Always use a credit card to pay; but always pay the monthly balance, in full, on time, each and every month, without fail.

To understand why credit cards are the best choice in the first place, let’s first summarize the problems with the other three choices. Currency is a bad choice, as you already learned in the budgeting chapter, because it leaves no trail and makes the compare and learn steps of the budget cycle a nightmare. Checks are better, but there can be a significant time lag between when you write the check and when the recipient cashes it, and this also complicates the budget cycle. In addition, checks are slow and inconvenient at the point of purchase.

Before we go on, let’s make sure that you understand the difference between debit cards and credit cards: if you don’t, that’s okay—lots of people don’t—and these cards are virtually identical to the naked eye. A debit card allows you to spend the money in your checking account, but not any more than that. Debit cards are like checks in this way; if you try to spend more than you have in your checking account, either the transaction will be declined or you’ll be charged an overdraft fee. But a credit card is different: it allows you to spend any amount of money up to your preauthorized credit limit, whether you currently have that much in your account or not. Each month, you are billed for the balance. If you pay the balance in full, you aren’t charged any interest, and then you go on to the next month. If you pay only part of the balance, then you are charged interest on the unpaid portion—usually at an extremely high rate. That’s where the danger comes in!

So back to our comparisons: debit cards are great for convenience, but they have two disadvantages. First, they are subject to something called blocks: when you make certain purchases such as buying gas, paying for a hotel room, or renting a car, transactions are often recorded for a much higher amount than you actually spent. A few days later, the high charges are reversed and the actual ones substituted in, but in the meantime the block could cause you an overdraft problem. The second problem with debit cards is that they don’t help you with your credit score.

But credit cards solve all these problems, and that’s why they are the best choice. They are convenient at the point of purchase, and the budgeting cycle is a breeze because all of your transactions are conveniently summarized each month, online, in easily downloadable form. There are no timing differences to deal with, and no blocks. Best of all, responsibly using credit cards improves your credit score. And you already know what responsibly means—paying off the balance in full, each and every month, no matter what your right brain says. Using a credit card is like driving a car—safe and indispensable if you know what you are doing, and very dangerous if you don’t.

While using credit cards without using credit is the best strategy for you eventually, it may not be the best strategy immediately. There are two reasons for this. First, you may not be able to qualify for a credit card yet (or the credit cards that you do qualify for don’t meet our criteria, which we’ll cover in the next section). Second, you may not yet have enough experience with controlling your spending through budgeting to trust yourself with a credit card. If either of these applies to you, then you can use a debit card as your interim strategy. Think of your debit card like training wheels when learning to ride a bike. As soon as you can qualify for a good credit card and you feel confident in your spending control skills, then switch over. Finally, if you’re having trouble qualifying for a card because you don’t have enough financial history, there is a special kind of card called a secured credit card that can be another excellent intermediate step—check it out.

Comments

[Emi the Financial Blogging Consumer]

What are your thoughts in terms of pro/cons of paying in-store with cash? I feel like in the moment, using cash is an effective way to get me to think "Do I really need this?" But after the transaction is done, I rarely go home and enter the cash entry in my budget and/or mint.com. Credit cards, although as effective for me to question my purchase at point-of-service, is great for tracking my purchases in my budget/mint.com.

[toni]

One of the most important reasons for using a credit card (following all the caveats mentioned) is, IMHO, the paper trail and the ease of problem solving if there is an issue with a purchase. I pay all bills as soon as they hit my computer and NEVER purchase anything that is not consumable immediately unless using a credit card. It's like insurance - one doesn't realize the true value of it until it is needed. And yes, the rewards currently in place certainly are a nice bonus. The credit card companies have much more clout than one individual does.

[FMF]

Emi --

Whether we pay with cash or credit cards, we always record the purchase (on a small notebook if cash) and then log it into Quicken later to be sure it gets tracked. If you use cash, you need some sort of process for recording those expenditures. And if you can't remember/don't want to/etc., then credit cards do offer that built-in tracking mechanism.

[Holly]

I always use credit cards whenever possible because, for some reason, I have very bad luck with carrying cash.

I will purchase a few small things with cash, come home, only to wonder what happened to the whole $40. I often end up thinking that the cashier didn't give me the right change (i.e. gave me a $5 bill rather than a $10) and sometimes I just can't remember where I spent it.

Other times I have just lost the cash (dropped it while taking it out of my pocket?)...I guess I just tend to be a bit careless w/cash since I am always using the cc!

[Chris Smith]

Emi, I agree that paying in cash can sometimes trigger a helpful “do I really need this?” thought. But if you’re like me, if the purchase is small – or I can talk myself into thinking of it as small – that’s all I need to justify it. Then, I’ll use the same reason (“it’s too small to worry about!”) to justify not recording it. It’s true that one small purchase doesn’t make or break a budget – but small purchases that are part of big patterns do. If I paying in cash without recording it, then I’ll never figure out the larger pattern.

Paying in cash at the point of sale will work just fine, if you’re good about recording it afterwards – but I’m just not that diligent. To me, the simplest solutions work best, and I just like the utter simplicity of: if it’s time to pay, reach for the card, and that way I know for sure it will be recorded. If I’m keeping the local convenience stores in business by buying Diet Pepsi’s one at a time every time I run an errand, I know for sure that I’ll see it in black and white at the end of the month. That’s why I recommend the simple “always use a credit card, never use credit” strategy in Securing Your Financial Futur

[Chris Smith]

Toni, GREAT point. If you’re ever in a dispute and want your money back, you’re in a much better position if you bought with a credit card. (I've never tried that with a Diet Pepsi, though.)

[Old Limey]

I gave up using cash many years ago.

I love the convenience, the rewards, the paper trail and the float they provide and have never paid 1c of interest to a card company.

I am sure I would think differently if I was a young single person, actively dating, an impulsive buyer, and trying to stay abreast of fashion and owning the latest hi-tech goodies.

[billyjobob]

I shunned credit cards for a long time and just used my debit card. Then after reading so much on FMF of the advantage of CC and the rewards available I decided to sign up for one. I was surprised when they turned me down. The reason was because I had no credit record they could find. I had use my last CC about 8 years ago, and that didn't show up on the credit reports. So even though I have worked the same job 30+ years, own my home, paid cash for my last car, never been late on a bill and have a substantial investment portfolio...I was a credit risk in their eyes. So, I signed up for a basic card through my credit union and am now in the process of building a credit history. Perhaps next year I will apply for a card with more rewards.

[Old Limey]

Billyjobob
You say you have a substantial investment portfolio.
I keep my money at Fidelity investments and they offer both a Mastercard that gives a 1.5% cash reward on everything and an American Express card that gives a 2% cash reward on everything. I suggest that you check with the institution where you keep your investments since they may have something similar.

Also if you happen to be a COSTCO customer they offer an American Express card that gives 3% on COSTCO gas, 2% on restaurants, and 1% on everything else.

[billyjobob]

Old Limey
I am with Fidelity also. I probably should see what they are offering. I actually have an American Express card that I have used with them for many years. I thought it was like a CC. But they do deduct the amount owed from me each month. When I ask why this wasn't on my credit report, I was told by the Fidelity rep that they do not report that card to credit agencies. Even the rep seemed a little surprised by this. He had to make a few calls to see why it wasn't reported. ?????
Anyway, good suggestion, I'll have to ask them what they offer that would be reported as a CC. Thanks for the tip.

[Deacon]

What do you think about the Dunn and Bradstreet study that shows people spend 12-18% more by using a credit card? If that is true, that would make 3% cash back not look so good...

[Catherine]

@Deacon,
Exactly. I've switched to just physical cash periodially. It does force you to spend less.

I'm not much of a shopper anyway, but if I only have 100 with me at the grocery store, I can only spend $100, not $106 or $118.

[FMF]

Deacon/Catherine --

As we've discussed here previously, those are average numbers, not percentages everyone falls victim too. That means people who can't control their spending might spend 30% more with a credit card while those who can spend no more at all.

Just like we don't strive for "average" in income, savings, etc., readers of this blog don't strive for the averages when it comes to the less desirable credit card results noted above.

[Old Limey]

@Billyjobob
The Fidelity AMEX card that I have is called "Fidelity Retirement Rewards". It is a green card with the AMEX logo on the front (in blue) and the card is managed and issued by FIA Card Services. When you get the card you have to provide a Fidelity account number that is not an IRA and not a Trust account. FIA then transfer the rewards into that account when they go over $50. The cards also show up when I check freecreditreport.com.

To also answer the previous 3 posts, my wife and I have a combined credit limit of $78,200 on 5 cards. That doesn't translate into us feeling any urge whatsoever to go into our nearby Mercedes dealership when we drive by and trade our '98 or '91 models in for 2012 ones, or to eat out at very fancy restaurants rather than our nearby ones that are quite inexpensive. I also have no problem buying used shirts and sweaters on eBay because although I wear some very expensive foreign brands I am far too cheap to buy them new. I like bargains. My 52 year old daughter is like me in many ways. She likes to visit thrift stores and the like and use her book scanner to buy very underpriced books for $2 max. and then sell them on Amazon.com, at prices ranging from $10 up to as high as $250. She receives $20K/month in alimony, has a Fidelity account worth $2.7M, and lives with her boyfriend in his $1.8M home, but it's all about the thrill of finding bargains.