In the last lesson, we looked at credit card debt and how much interest you can end up paying. Credit cards are one of the best financial tools out there if you pay your balance in full every month, and one of the worst if you don’t.
Debit cards are somewhat similar to credit cards. But there’s a big difference in how you pay for purchases. With a debit card, the bank isn’t fronting the money to the store where you make a purchase. The money comes right out of your checking account. There are no grace periods; usually the money is taken out of your account within 24 hours.
Credit cards can also have other benefits that debit cards may not offer. For example, fraud protection can be better on a credit card. Just from a peace-of-mind perspective, it’s much nicer that a criminal doesn’t have direct access to your bank account if they steal your credit card. If you’re interested, see more details in this article.
Many debit cards may have the Visa or Mastercard logo on them, which means they can process a purchase the same way a credit card would. But, if your card is only a debit card, the purchase will still act like a debit purchase; there won’t be a grace period before the money is taken out of your bank account. See more details in this article.
Some people will advise you to never get a credit card, and to only use a debit card. They assume that you won’t be able to resist the temptation to carry a balance, lose your grace period, and start paying exorbitant interest.
There is some truth to this; according to Value Penguin, 41% of households in the United States have credit card debt, and the average debt amount among those households is nearly $10,000. 15% interest on that $10,000 means you’re sending $1,500 a year to the credit card company.
I hope the last lesson will make it more likely that you won’t be in the group of people who carry a balance on your credit card! You will have to have the discipline to pay off your balance every month. It’s easy not to. Just pay less than the full amount and you just took out a loan with a 15% or 20% interest rate.
If you pay off the balance every month, the credit card rewards are nothing to laugh at. Suppose you spend $1,000 a month on your credit card. This isn’t that hard once you have a job and are living on your own. Groceries, cell phone bill, Netflix, restaurants, travel; you can put almost everything on a credit card these days.
What does 2% cash back look like over time? Let’s assume you invest that money at a 5% annual rate. Open up that spreadsheet! And try to create it yourself before looking at my spreadsheets below.
Cell E1 is the amount of cash back the credit card company is giving us each month. You can change that to try different amounts.
The formula in cell B3 is a little tricky. First, remember that the 5% is an annual return, but we’re working with monthly data. 5% interest every month would be great, but it’s not very realistic!
The interest you earn is your previous balance plus the interest:
Previous balance: B2
Interest: B2 * $F$1/12
You could keep those separate in the formula and end up with:
=B2 + B2 * $F$1/12
I’ve taken the B2 out of both parts and made the formula:
=B2*(1+$F$1/12)
And then we just add the $20 of new money at the end:
=B2*(1+$F$1/12) + $E$1
How long does this go on? There’s no end date, unlike a mortgage or other debt you’re paying off. It goes for as long as you keep the credit card!
Let’s see how much you have after 40 years, so 480 months:
The credit card company has given you $20 a month for 480 months, or $9,600. And your 5% return means you have a total of over $30,000!
Keep that in mind when you get a credit card. If you don’t pay off your balance each month, you can pay tens of thousands of dollars in interest. But if you do pay it off, you can earn tens of thousands! It’s a huge swing in your assets over time.