In our Budgeting Clinic series, Tom Francis, head of personal finance at Octopus Money, answers your questions about all things personal finance. Tom is a fully qualified and chartered financial planner. Worried about how your savings are shaping up for the future, or need a plan for how to get out of debt? Drop him an email on money@theipaper.com.
Question: I usually use a rewards credit card to do my Christmas shopping. Last year I got an Amex everyday, which in the first few months you get 5 per cent cashback on. I got quite close to the limit on the card as I end up spending over £1,000 in the run up, but I always had enough in my account to pay it off. It was more as a method of getting cashback. Are they any bad side effects from doing that, in terms of damage to my credit score or ability to get a credit card or mortgage in future?
Answer: Before answering directly, I’m going to use an analogy to break down how rewards cards work and what the benefits are. Bear with me here, but using a reward credit card is a bit like taking protein powder.
Combine it with a solid diet, and it can have huge benefits to your overall health and nutrition.
If all you ate was protein powder, you (as well as your stomach) would be pretty unwell. It’s the same with a reward credit card.
When it comes to your finances, it is critical that you combine your use of a credit card with a healthy combination of planning principles.
First up, you need your nutritious emergency fund (of at least three months of your outgoings). Next, you ideally need an income which regularly covers your outgoings (including covering spending on your credit card).
This combination helps to make sure that you are not building up debt, which might not be able to be repaid within an interest-free period (usually 30 days on credit cards, but could be up to one year). This is never more important than in the run-up to Christmas.
So, if you have a balanced diet of cash savings and regular income, then a rewards credit card is a powerful supplement to your finances.
It sounds like you are doing an excellent job of already ensuring you have the cash savings available to repay your credit card in full, and on time. To be clear, if you keep doing this, there are no immediate downsides or bad side effects of doing this.
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In fact, there are upsides.
Firstly, regularly repaying a credit card, on time and in full, is a very effective way of building a strong credit score. You are proving that you have both the ability and discipline to repay a loan.
For things like long-term loans or a mortgage, banks really take this into account when you make an application. In fact, there have been instances where wealthy people, with larger amounts of cash, have struggled to obtain a loan because they have never proved their ability to repay a loan in the past.
This can happen when someone has never used credit and therefore has no repayment history. Lenders often prefer a clear track record they can measure, and consistent credit card management paints a picture of you as a reliable lender.
Secondly, there are the rewards themselves. Receiving 5 per cent cashback on purchases you were always going to make is a nice way to get free money or a benefit. Importantly, as you noted, these deals or rewards can fade or become less attractive over time, so it helps to keep checking if your reward has continued, or expired after a certain amount of time.
Many providers also change terms based on broader market conditions, so staying aware of these small print adjustments ensures you continue to get the best value you can.
Hopefully all of the above makes sense, and sounds fairly sensible. Now it’s time to tackle the elephant in the room with reward credit cards, being tempted into spending money which you otherwise wouldn’t have.
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For me, this is a big no-no. The famous personal finance personality Dave Ramsay says, “no one ever got rich from free air miles”, and I totally agree. The goal of reward cards should be as a supplement to your usual financial life. You should ideally not find yourself in the position of being tempted to spend more money in order to access a better reward.
Often, these cards are designed to tempt you into spending more, whether it’s about accessing “the next tier” or “you’ve qualified for an increased credit limit”. It can be hard to resist these temptations, but in the future you will thank yourself by ensuring your spending is not influenced by this. A clear spending plan or monthly budget can help you recognise when the card is serving you, rather than the other way around.
If you do find yourself in the position where you think “I can spend a little more”, then consider your options before splashing the cash. Maybe topping up cash savings, considering investing, or boosting your pension could make a lot of sense. When you have the fundamentals in place, steady income, a solid emergency fund, and the discipline to repay the balance in full – the card can be a smart asset that works with your lifestyle.
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