How to Use Credit Cards Wisely

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Narrator: It feels like every time you open the mailbox, there's a shiny envelope offering thousands of free miles, zero interest, or bonus cash back just for opening a new credit card.

But are any of those rewards actually worth it?

Credit cards can be powerful tools if you use them wisely. You can use credit cards to build credit, pay in a pinch, and, of course, earn rewards.

But there's one big caveat: You have to pay your balance in full. Every. Single. Month.

That's how you can avoid paying interest, which is what can make credit cards dangerous.

As of November 2019, the average credit card interest rate was more than 17%, so debt can pile up fast when you're carrying a balance from month to month.

The smart way to use credit cards is to reap the rewards without paying the interest.

But with all the rewards out there, how do you choose between cards? And how many credit cards is too many? It helps to understand the types of rewards cards offer.

Many credit cards offer sign-on bonuses.

For example, a card might offer $150 in cash back for spending $500 within the first three months. This sign-on bonus typically is where you can get the most reward.

If that card offers 1.5% cash back on regular spending, you'd have to spend $10,000 to get that same reward.

It might be worthwhile to open a new card just for the sign-on bonus but be careful. If a sign-on bonus requires you to spend more than you typically would, it isn't worth blowing your budget.

While having multiple credit cards can help build your credit history, having too many new lines of credit can actually lower your credit score. So, don't open cards willy-nilly, especially if you think you might need to apply for a loan within the next two years.

There's no magic number of credit cards that's best, but typically having a couple cards from different networks can offer the most flexibility.

In addition to sign-on bonuses, many cards offer some kind of reward for ongoing spending. Those rewards have different names: cash back, miles, points, but they all boil down to the same thing: incentivizing you to make purchases on the card by offering a small reward for every dollar spent.

Some people maximize these rewards by using credit cards as their go-to form of payment for every purchase.

But again, this only makes sense if you pay off the balance in full every month.

It might pay to align your cards with your interests and spending habits. If you travel a lot, a card that offers credit toward flights, often called miles, may be right for you; if you're trying to focus on budgeting, a card that offers cash back on necessities may be your best bet.

Regardless of the form of reward, when comparing cards, look for the highest reward rate.

To do this, calculate the dollar value per point.

For example, if a flight costs 50,000 miles, or $500, each mile is worth a penny.

If you get two miles per dollar, you get two cents per dollar—the same as 2% cashback rewards.

While credit card rewards can be a nice perk, there are a few things to watch out for.

Some rewards cards have higher interest rates than a regular, run-of-the-mill credit card.

Fifty-nine percent of Americans with rewards cards carry a balance.

If you're one of them, you could be costing yourself more in interest than you're earning in rewards.

Also, don't max out your credit card. This could severely damage your credit score.

Try to keep your spending to less than 30% of your credit limit. That means if your limit is $10,000, don't put more than $3,000 on your card.

Finally, lots of rewards cards have an annual fee, some up to several hundred dollars.

To make sure the perks justify the cost, estimate how much you'll spend on the card, calculate the reward you'll get, and make sure it exceeds the annual fee.

In short, using credit cards the smart way means two things: choosing cards with high reward rates that align with your spending habits and paying off the balance in full every month.

Following these ground rules for using credit cards can help you benefit from purchases you already plan to make without piling up debt.

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