Give Yourself Some Credit

Originally published in MoneySense

July 2012

Most of us love the convenience of credit cards, but poor credit management can dent your net worth

To some, credit cards are a modern day convenience; to others they're weapons of mass consumption, with the potential to deal a blow to your financial well being. To become financially independent, you need to make sure you're in the former camp. In fact, most financial advisers would say that effective credit management is even more important than saving.

That might sound counterintuitive, but wealth isn't measured by how much you save; it's measured by your net worth, which accounts for all of your debts and assets. Saving has little value if you continue to pile on debt. "People generally know what they owe, but they have problems understanding the details, such as how interest rates, minimum payments and special introductory credit card offers really affect their debt," says Darryl Robinson, a fee-only adviser in Selkirk, Man.

One of the best ways to manage credit is to choose the right card for your situation. "You need to ask yourself a few questions," says Sheila Walkington, co-founder of Money Coaches Canada. "Are you going to pay off the balance every month? Do you need car or travel insurance? Is a points or rebates card right for you?"

Pat White, the executive director of Credit Counseling Canada in Toronto, agrees. "One or two all-purpose credit cards is all you need. I know that offers will come in the mail or are in the stores, namely that they will give you a certain percentage off the purchase because you sign up for the credit card. But don't be shortsighted or impulsive. Instead, really evaluate why you need the credit card and how you will be using it."

When choosing a card, you need to decide whether to get a low-rate card or a rewards card. "Always shop around for the lowest-rate card if you carry a balance," says White. The interest rate on reward cards is typically 19% or higher so you'll pay much more in interest than you will get in rewards.

On the other hand, if you pay off your balance every month then you have quite a few options to consider. There are three main types of reward cards, including cash back cards, which give you an annual cash "dividend" amounting to a set percentage of your spending; travel cards, which reward you with points or miles that can be redeemed for airline flights and other rewards; and finally, retail merchandise cards, which provide points that can be redeemed for particular products, such as groceries and gas. "If you put a high volume of stuff on your card and have the discipline to pay it off monthly, then choose the card that best meets your lifestyle," says Rick Coyle, a fee-only adviser in Kemptville, N.S. "The rewards can be very valuable."

That means that if you're a mom with three kids, for instance, then go with a groceries points card. If you prefer cash up front, then choose a dividend reward card that pays you a percentage (usually between 1% and 2%) of your purchases in cash. You'll be smiling when you receive a cheque at the end of the year. Just make sure that when you charge something, you have the money ready in a savings account where you won't touch it. You want to make sure you always have money to pay your credit card bill in full. "Remember, the points are just a bonus," says Rob Boulanger, Director of Credit Counseling Services of Atlantic Canada in Saint John, N.B. "Make sure you're not paying for them through interest payments."

If you travel a lot then go with a card that offers perks like free rental car insurance, travel baggage insurance or trip cancellation insurance. These add-ons can save you hundreds or even thousands of dollars. "If you have a good system and can budget properly, these cards are great," says Boulanger. "These people are getting a lot of free trips and free hotel rooms."

In some cases, it may even be worth paying an annual fee to get a card with better rewards, especially if you spend more than $3,000 a month on your card. It works like this. If you have a dividend card that pays you 1% of your purchases and you spent $3,000 a month you'd get back $360 at the end of the year. But if you paid a fee of, say, $80 to increase your rewards to 2% then you'd get $720 back. After subtracting the fee that's still $280 more than you'd earn using the no-fee card. "Just do the math and make sure you're coming out ahead-after fees," says Boulanger.

You can increase the rewards you get by paying for regular monthly expenses-utilities groceries, gas-with your card, but this only works if you pay off your card balance in full every month. Some cards even offer purchase protection, so if the item you buy on the card is lost or stolen within a specific period-usually 90 days-the card will replace it. Or, if the manufacturer's warranty runs out, it may still be covered by your card's warranty program. "These add-ons aren't very sexy but they can be quite valuable when you need them," says Janet Freedman a fee-only adviser in Toronto.

Best of all, credit cards give you valuable information about your monthly spending, all in one concise statement. Even better, some credit card statements break down your spending by types of purchases so you can see at a glance what categories your monthly spending is going to. "If you have to dig deeper than that, then you can go ahead," says Boulanger.

Whatever card you choose, keep your credit card statements for a full year at a time. They can be valuable when it comes to helping you track and manage your money. Effective credit management is key to ensuring you have positive cash flow. Your adviser can help you pick the right credit strategy for your situation.

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