Young Lawyers Guide to Credit Cards
Executive Summary
Credit cards are commonplace in our financial lives. Credit cards offer some great benefits like buy now and pay later, ability to dispute incorrect or fraudulent charges, and collecting rewards. But abusing a credit card can leave you paying fees and high interest payments that negate the benefits and eventually may lead to bankruptcy. Young lawyers who follow credit card best practices like spending within their means, paying their debt off on time, and maintaining an emergency fund can almost entirely avoid the pitfalls of credit cards. Employing these best practices and strategies to maximize their credit card rewards allows young lawyers to smooth their monthly expenses, improve their credit scores, and offset some of their purchases with rewards.
Credit cards are the most common form of debt in America. More Americans have credit cards than mortgages, car loans, and student loans. They are a great tool to use in your financial life, but like all tools, they can be misused and harm you.
When young lawyers use credit cards responsibly, they can build up their credit score, better manage their monthly spending, and benefit from rewards. When young lawyers use credit cards irresponsibly, they can destroy their credit score, add to their debt burden, and have expenses that far exceed their income.
While there are downsides to credit cards, young lawyers can almost completely avoid them when they fully understand the best practices and pitfalls of credit cards. This blog will explain how credit cards work and some strategies young lawyers can use to get the most out of their credit cards.
The Basics of Credit Cards
Credit cards may look exactly like debit cards, but they work differently. When you swipe your credit card, the credit card company pays for your purchase. Instead of paying the seller for your purchase, you have to repay the credit card provider. A debit card pays the seller immediately with cash out of your bank account.
Credit Card Benefits
Since the credit card provider pays on your behalf, you benefit from buying now and paying later. The typical time to repay a credit card purchase is one month. One month is not a long time, but it is helpful when you have expenses that vary in size over a month. Rent or mortgage payments alone can take most of a single paycheck. If you have additional costs until your next paycheck, you may find yourself without enough cash to make all your payments.
Credit cards help smooth out monthly expenses. Young lawyers can use their credit cards to pay for the varying size of monthly purchases and then later repay them after earning their future paychecks.
Credit cards are also helpful for disputing improper or fraudulent charges. If someone steals your debit card number, they can take money directly from your bank account. With a credit card, you have the opportunity to dispute charges. When young lawyers flag incorrect payments, the credit card company will deal with the merchant on your behalf. Having another party deal with the dispute can help you receive a refund of your money without spending time resolving it yourself. Credit cards can also help you if you are a victim of fraud. Visa and Mastercard have zero liability policies for fraudulent charges, which means you are not liable for any legitimate fraud charges.
Credit cards also offer rewards. When you use your credit card for your purchases, you can receive cash back rewards or points you can redeem in the future. Debit cards do not reward any benefits for spending money. Using a credit card with reward offerings can offset the cost of a small portion of each purchase.
Another benefit of using them is that they can boost your credit score. Credit cards are a form of debt. When young lawyers responsibly use their credit cards, they create a long history of on-time debt payments. When young lawyers with a high credit score apply for loans, lenders can see that they are responsible for repaying their debts. Demonstrating you are likely to repay your debt means creditors will give you more loan options and lower interest rates.
Drawbacks to Credit Cards
Credit cards are not a perfect way to spend. There are plenty of stories where people have overused their credit cards and were later unable to pay. These are cautionary tales of the potential dangers of using credit cards.
The most well-known drawback of credit cards is the high-interest rate for remaining balances. The interest rate only applies to an unpaid credit card balance. Most people make their credit card statement payments on time and in full. When people do not pay their balance, any remaining balance usually faces an interest rate charge of 12%+. This interest rate is significantly higher than the interest rate for student loans, mortgages, and auto loans. This interest rate also begins to accrue interest daily. So each day you have an outstanding balance, your amount owed increases.
Example: A young lawyer spends $500 with their credit card this month. At the end of the month, they receive a credit card statement showing they owe $500. When the payment is due, the young lawyer can only make a minimum payment of $75. The day after the balance is due and the grace period is over, $425 begins accruing interest. If a few weeks later, the young lawyer has $425, they will not be able to repay their outstanding debt because after accounting for accrued interest, the $425 overdue balance is now greater than $425.
With a high enough balance and enough time, the debt owed can spiral out of control. High credit card debt can eventually lead to bankruptcy.
Another drawback to some but not all credit cards are the fees charged. Some credit cards will charge users an annual fee to use their credit cards. The cards may offer bonus rewards, but without a high level of spending with the credit card, young lawyers can spend more to maintain the card than they receive in benefits.
Best Practices for Credit Cards
When young lawyers make good decisions with their credit cards, they can almost completely remove the drawbacks of credit cards. Avoiding the downside and benefiting from the upside of credit cards helps young lawyers improve their financial lives.
Spend Within Your Means
Most people get into trouble with their credit cards because it is easy to overspend. Swiping a credit card results in nothing coming out of your bank account. People can spend more than they currently have because they assume they will use future paychecks to repay their purchases today. If they do not hold themselves accountable, the total of all of their small charges can quickly exceed their future pay. Then interest adds to the future cost.
To negate this negative feedback loop, young lawyers should only use their credit cards for purchases within their means. Spending within your means requires vigilance with your credit card amounts so that you never have balances above what you make. You are a responsible credit card user when you manage your credit card spending.
Pay Off Credit Cards In Full and On Time
When you receive a credit card statement, it can be less than your current balance because there is a delay between the statement date and the date your credit card payments are due. Young lawyers who can pay off their credit card balances plus the extra balance on the card will be spending well within their means.
There is no penalty for only paying your balance each month, but leaving a revolving balance on your credit card makes it more likely that you may not be able to repay your balance in the future.
Credit cards might also give you a minimum payment due. Disregard that number unless you are in an unfortunate financial situation. Making minimum payments means that the remaining balance will start accruing interest.
Also, always make your payments on time. Some credit cards offer a grace period but missing even one on-time payment can significantly damage your credit score. Put the credit card due date on your calendar and set reminders. These payments are a high priority in your financial life.
Your Credit Limit Is Not Your Spending Limit
Credit cards have spending limits. A spending limit is the maximum debt that you can have outstanding while still being able to use the credit card. But just because you have a credit limit does not mean you should spend that much money.
Your credit score considers many factors, one being your credit utilization. This factor divides your statement balances by your credit limits. If your statement balance equals your credit limit, you have 100% credit utilization. Ideally, your credit utilization should be below 30%. The lower your credit utilization is, the better.
Rewards Supplement Your Spending
Most cards today have some form of reward. You can receive cash back for every purchase, bonus points for various spending categories, bonus miles if you shop at certain stores, and large bonuses if you spend a certain amount within a promotional timeframe.
Credit card rewards incentivize people to use their credit cards more, which may lead people to spend above their means. Responsible credit card users only view the rewards as a supplemental benefit for their typical spending. Rewards should not drive your purchase decisions.
Think of the rewards as a bonus for spending within your means. Otherwise, you might find yourself filling your entire garage with blenders for a few extra credit card points.
Have an Emergency Fund
There may be a time in your life when you have to spend more than you typically spend but lose your job. When this happens, you may not have the ability to repay your statement balance. Adding interest to your credit card debt can turn a bad situation into a worse one.
To prevent this situation, have an emergency fund of 3-6 months of expenses set aside in a savings account. If a high unexpected expense arises or you lose your job, you can use the money from your emergency fund to pay off your credit card debt.
Credit Card Strategies
When you implement these best practices, you set yourself up to benefit from using your credit cards. There are plenty of ways to take advantage of credit cards, and here are a few strategies you can use in your finances.
Choose a Credit Card That Rewards You For Current Spending Habits
Every credit card comes with a unique set of rewards. Some cards offer you a level amount of cash back for all purchases. Other cards may reward you with boosted cash back for certain purchases. If your work requires you to drive frequently, a credit card that gives you extra rewards at gas stations can be beneficial. If you prefer to eat at home instead of at restaurants, look for a credit card that gives you bonus points at grocery stores or food delivery instead of restaurants and bars.
When selecting a credit card for the rewards, remember that credit cards are for responsible spending, not bonuses. Don’t get a credit card with 5X points for traveling if you can’t afford to travel. It will only incentivize you to spend on something you can’t afford.
Take Advantage of Sign-Up Rewards When the Opportunity is Right
Every day I see an ad online or in the mail for a sign-up offer on a new credit card. These sign-up rewards can be lucrative at the right moment. If you are planning to take a trip to Europe next year and you receive an offer for bonus miles in your first year, then it might make sense to open that card.
If you see a card with a large sign-up reward once you spend a significant amount of money and you know you have a large purchase like a house renovation or a large tax payment, take advantage of that. Timing sign-up bonuses with significant expenses can be a great way to capitalize on rewards if you have planned to pay for these expenses without this new card.
There are endless sign-up bonuses, but you should not have an equal number of credit cards. Having too many credit cards can hurt your credit score. They can also make it increasingly challenging to keep your credit card bills paid on time. When you think you are ready for a new credit card, explore the sign-up rewards. Otherwise, keep using the cards you currently have.
Redeem Rewards for Specific Goals
Responsibly taking advantage of credit card rewards will not help you retire 20 years early, but they will help you with small goals. Using all of your points or cash back to achieve a single goal is a strategy for rewarding good spending behavior.
If you like to travel, put all your reward points towards your next trip. You may be able to fly free and possibly even upgrade your seats!
If you want to boost your savings, set up automatic cash back redemptions that deposit directly into your savings account.
Applying rewards to your goals can make achieving these goals faster and cheaper. It’s a great way to reward yourself for responsible credit card use.
Final Takeaways
Credit cards can be your best friend or your worst enemy. Be selective with the cards you carry and how you use them.
Young lawyers who want to boost their credit score, earn rewards, and smooth out their monthly expenses can benefit from credit cards. When you spend within your means, make on-time payments, always pay off your balance, and view rewards as a bonus rather than a spending incentive, you will see the most benefits from responsible credit card usage.
Employing best practices and the strategies listed above in your credit card usage will ensure that you avoid the pitfalls of credit cards and benefit from the rewards.
Credit cards are just a small part of a young lawyer’s financial life. When used correctly, their benefits are barely noticed, but when they are mishandled they can devastate a financial life. Part of the Developing Financial Process deals with credit cards. It includes reviewing your credit report, analyzing current spending patterns, and identifying new credit cards that align with spending and goals. Whether you are trying to pay off credit card debt or you are looking to optimize your credit card usage, Developing Financial can help. Schedule a free Meet & Confer to talk about your current credit card usage. We can also discuss other challenges or opportunities you face in your financial life.
Disclaimer: Nothing in this blog should be considered financial advice or recommendations. Your questions are unique to you and your own personal financial circumstances. You should consult with a financial professional before making a financial decision. See full blog disclaimer.