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When and Why Using A Credit Card Is Good Sense…And When It’s Not

When it’s time to pay, you have several options. Cash, debit cards, and credit cards are accepted almost everywhere. Each method has benefits and drawbacks. Does it really make a difference which method you choose? This post examines the question in light of the hidden fee structure of credit cards, and explains why the best way to pay, from a personal finance perspective, is to use a credit card…except, of course, when it isn’t.

Why Use A Credit Card

Both cash and debit cards are tied pretty directly to your bank account. Pay with either, and your balance goes down. There are several obvious differences too: debit cards are often more convenient, harder to steal, and generate clear records of all your transactions.

The difference between a debit card and a credit card is less obvious. Both have the same advantages over cash: they can be used where face-to-face payment is not possible (eg, online shopping), and both provide some level of payment tracking and theft protection. On the surface, there are no compelling reasons to use one over the other.

Under the surface, however, there are some substantial differences. Despite sharing the same form factor (3.370 x 2.125 inches) and transaction method (just swipe it!), paying with a credit card is actually much more complex, involving several transactions between intermediaries before the vendor is ultimately payed, several days later. The details of these complexities is beyond the scope of this post, which will focus instead on the benefits and drawbacks to YOU, the consumer, of using a credit card vs a debit card or cash. As a sidenote, whenever ‘cash’ is used for the rest of the post, it refers to both a debit card and physical legal tender.

Tangible Benefits and Drawbacks

When you pay a vendor with a credit card, you introduce a 3rd party (the Credit Card Company: Visa, Mastercard, etc.) into that transaction. Like any good company, Credit Card Companies need to make money. One of the ways they do this is by taking a percentage of every transaction they are involved in. This percentage can be anywhere between 1% and 4%.

In other words, if you buy an item for $100 and pay with a credit card, the vendor has to pay between $1 and $4 to the Credit Card Company. Typically, vendors don’t have a spare 4% in their profit margin to lose at each point of sale. To counteract this, any vendor that accepts credit cards will charge 1% – 4% MORE for their items than an equivalent vendor that does not accept credit cards. They don’t advertise this fact, of course, but they do it. Credit cards are more expensive for a vendor to accept than cash, and vendors must pass on that charge to their customers in order to stay in business.* What that means is, ALL customers are paying 1% – 4% more…but only the credit card-using customers get any of the benefit.

The main tangible benefit that cash-using customers miss out on is the rewards offered by credit card companies. Typically these rewards are 1% or 2% ‘cash back’, which means that the Credit Card Company refunds its customers 1% or 2% of everything they purchase using the card.

Another way of looking at it is that an item costs 1% – 2% LESS, when you pay using a credit card, than that same item when you pay with cash. This difference can easily add up to hundreds of dollars per year. This phenomenon was studied and analyzed in depth in the 2010 paper “Who Gains and Who Loses from Credit Card Payments? Theory and Calibrations” [LINK]. In analyzing this transactional difference – cash users paying more for items while credit card users receive the all cash-back benefits – they found that “On average, each cash buyer pays $149 to card users and each card buyer receives $1,133 from cash users every year, a total transfer of $1,282 from the average cash payer to the average card payer.” That’s a big difference, and it’s based completely on how you choose to pay for items.

The main tangible drawback of using a credit card is the usurious interest rates and the real possibility of falling into high-interest debt. This is a significant risk which an individual needs to seriously weigh in their decision regarding credit card use, since even a few missed payments on a relatively small balance can wipe out that 1% – 2% cash back benefit. Unfortunately, Credit Card Companies make a LOT of money from such high interest rate debt: “On average, each household with a credit card carries $8,398 in credit card debt” for Americans in 2019. [LINK] Credit Card Companies entice users by advertising “low” interest rates, but it is important to note that these interest rates are still high by most reasonable loan standards, and choosing the optimal interest rate repayment structure is difficult. In one 2006 study, 40% of people chose sub-optimal repayment contracts, “with some incurring hundreds of dollars of avoidable interest costs.” [LINK< direct pdf download]

Add to that the fact that Credit Card Companies can change their rates at any time and for no reason, a good rule of thumb is this: if you care what your credit card’s interest rate policy is, you probably shouldn’t be using a credit card.

If you care what your credit card’s interest rate policy is, you probably shouldn’t be using a credit card.

Intangible Benefits and Drawbacks

Not paying off your credit card can quickly lead to financial ruin. However, if you can and do pay off your credit card each month, I recommend using it for almost everything. In addition to the ‘cash back’ benefit discussed above, two major intangible benefits to using a credit card include:

Protection

Losing a credit card costs you nothing except a little hassle. Losing cash costs you 100% of the value of that cash. Credit Card Companies generally don’t put their customers on the hook for charges on a lost credit card (it’s bad for their business in terms of consumer goodwill). Furthermore, credit cards offer protection against legitimate purchases where the product was somehow faulty or misrepresented by the vendor; an assurance not available when paying with cash.

Tracking

Putting everything on a single card means a monthly report of everything you bought, from whom, and when. This is immensely helpful when trying to establish a household budget or track personal spending. 

Finally, despite all the benefits of using a credit card, there are some intangible drawbacks as well:

Carelessness

Paying with a swipe can lead to more careless spending. Many studies have shown that paying with credit cards increases impulsive spending, and one even found that consumers who payed with a credit card purchased more junk food than consumers paying with cash [LINK]. If you spend more irresponsibly when paying with a credit card, the benefits of 1% – 2% cash back are quickly canceled out.

Harming Small Business

As stated earlier, paying a vendor with a credit card means up to 4% of your money goes to the Credit Card Company, as opposed to paying with cash, where the vendor keeps 100%. This is a personal decision, but if I’m at a big chain, like Wal-Mart, I’m not inclined to give up my 2% cash back just so Wal-Mart can keep more of my money…and Wal-Mart is so large their bottom line isn’t affected either way. At my favorite local independent retailer, however, I might make a different decision. By paying with cash here, I’m helping that business stay open and keeping money in the community – that 4% fee stays with the vendor instead of being transferred to some Credit Card Company a thousand miles away. Not every benefit can be neatly tracked on a personal finance spreadsheet.

In conclusion, the cash back and fee structures of credit card usage means that you can optimize your finances by using a credit card to pay for almost everything…but only if you maintain responsible spending habits AND pay off the balance in full every month. If that’s a risk for you, it’s far better to stick with cash.

* Credit card-accepting vendors generally increase the price of ALL their goods by a flat %, mainly for simplicity. Vendors are NOT ALLOWED to charge individual customers more for using a credit card, due to an NSR (No Surcharge Rule) in their contract with the Credit Card Company. Vendors ARE ALLOWED to offer cash-paying customers a discount, but in practice they rarely do.