Keeping Credit on Your Side

Andrew Busa:

Hi, this is Andrew Busa. Welcome to another The Adviser You Can Talk To Podcast. Today I am joined by Michael Dillaire, he’s a fellow financial planner and certified financial planner, and today we are focused on credit.

Michael Dillaire:

Hey Andrew, thanks for having me. It’s my first podcast. Excited to be here.

Andrew Busa:

Yeah, we’re excited to have you. It’s always exciting to get that first podcast under your belt, and you’re the perfect person to have as the guest on this episode because you have a lot of experience in this area. So we will cover five sort of large topics today when we’re talking about kind of credit, credit cards, all that.

First, we will hit on just the basics to set the groundwork, cover some terminology that you might hear us refer throughout this episode. Second, we’ll hit on the importance of interest rates and carrying balances and what that kind of means for your financial plan. Third, we will hit on perks. Everybody loves perks and the points that you get from credit cards. So we want to talk about that. We will then talk about how all this sort of goes into managing and understanding your credit score and why that’s important for your financial plan. And then finally picking a card that’s right for you based on all the information that we’ve talked about today.

Michael Dillaire:

Excited to get started.

Andrew Busa:

Okay, perfect. So like I said, today we are primarily focused on credit cards, right? So when we talk about credit there are a whole host of different tools that you can use at your disposal when it comes to your financial plan, like home equity lines of credit, mortgages, portfolio lines of credit, those sorts of things.

Today is focused on consumer credit, and you’ll see why as we go through this episode. But those other topics we might save for other episodes down the line. But so let’s get into the basics, give us some terminology and help us understand kind of what do we need to know in the fine print with our credit cards, Mike?

Michael Dillaire:

A credit card essentially acts as a loan from a bank to cover costs now to be paid back later. During the billing cycle, which is the time between the statement closing dates, you rack up sort of a tab. And then when the statement cycle closes you owe the balance of the tab, or as it’s referred to as the statement balance. You then have a grace period to pay back the balance before you start to be charged interest. And if you don’t make at least the minimum payment of the statement balance when it’s due you’ll be charged a late fee.

Andrew Busa:

Okay. That’s good to know. And when you talk about how much you might be charged and all that, how do you know that as the consumer?

Michael Dillaire:

Yeah. So it’s in the fine print, but the late fee is a standard nominal amount that the credit card provider will set. But the rate at which you’re charged interest is called APR, or annual percentage rate. Now the APR percentage is the amount of interest charged to the borrower over the year. So for example, if your APR is 12%, you’ll be charged 1% a month on the balance. So 1/12th of the APR rate.

Andrew Busa:

Okay, that makes sense. And I’m glad you touched on APR right at the beginning of this, because you’ll probably hear us reference that a few times throughout this episodes. So now you know what that is. But I think that’s a good overview of the basics here. And it’s worth pointing out, you mentioned in your example that you just said if your APR was 12%, well that’s a high interest rate or higher rate of interest than you would otherwise see on those other types of loans that we mentioned before. And that’s because your credit card is not backed up by an asset, so interest rates are typically going to be higher there as opposed to your mortgage which is backed up by your house so you see that much lower rate of interest.

Andrew Busa:

But if we now transition to our next topic and really keep on that theme of interest rates and balances, I’m curious to hear from you when you’re putting together a financial plan you think about balances, potentially high credit card balances when you see those. How do you feel about carrying balances generally?

Michael Dillaire:

Yeah. So rule of thumb with credit cards, don’t spend what you don’t have. Normally we wouldn’t recommend carrying balances on your credit cards as the APR rate, as we mentioned before, can be quite high. And the 12% I said before is not usual. It’s usually the high teens, low 20%. And paying interest is avoidable by paying the balance in full at the end of the month. So the due date and balance are clearly shown in the credit card statement, and you can set up automatic payments for most banks for the balance to be paid off from your checking account at the end of the month. Or set up an automatic payment of just the minimum balance, which I usually would recommend people do as a last form of defense before the end of the grace period.

Andrew Busa:

Mm-hmm. Right. So that’s always something to keep in mind. And I feel like the high APR, high interest rates, is this maybe a reason why sometimes people are kind of scared off of having multiple credit cards or having any credit at all do you think?

Michael Dillaire:

Yeah. Absolutely. So credit cards have one of the highest interest rates than say, like you said before, student loans, mortgages, car loans. And high balances being charged with APR percentages nearly 20% can really cause a lot of interest. And for example, in January if you had a $10,000 balance on a card with 20% APR, you’d be charged almost $170 of interest just for January’s balance. And this will continue every month until the balance is paid off. And in future months too, that interest you’re charged in a prior month will be added to the balance sort of having a compounding effect in future months.

Andrew Busa:

Right. So if you’re carrying a balance, that can add up very fast.

Michael Dillaire:

Definitely. And the example I said before didn’t even mention fees. So some cards have an annual fee. And as I mentioned earlier too, they can be charged a late fee if you don’t pay the minimum payment. So it’s a hard pill to swallow paying late fees on a card you’re paying an annual fee on blended with interest charges. So it can be a deep hole to get out of without proper planning and budgeting.

Andrew Busa:

Right. And so you mentioned planning there, if we kind of pull this back, take a big picture view of where and how credit and credit cards fit into your financial plan. Mike, when you’re creating a financial plan for somebody and you see a high credit card balance or multiple high credit card balances, what’s sort of going through your head there with regard to sort of the rest of that person’s financial plan?

Michael Dillaire:

Yeah. So seeing high credit card balances I’ll immediately look at the cash on hand. So we normally would recommend having that emergency fund of 6, 9, 12, whatever amount of months of fixed expenses that you’re comfortable with in cash. But those incredibly low interest bearing funds and bank accounts may be better used by paying off debt if you’re above and beyond that emergency fund. And if there’s not cash on hand, to me it’s time to reassess the budget beause you’re probably spending more than you make on a regular basis. And during financial plans we’ll notice that when we look at like cash flow statements.

Andrew Busa:

Yeah, that’s a really good point. Sometimes the credit card can sort of just be a really quick window into your financial health, and we’ll also get into credit score and how that’s also usually an indicator of your overall financial health kind of like your blood pressure really. But I like the point that you made there. I think if you’re constantly carrying high balances on a monthly basis, that’s usually a good opportunity to just take a look at your budget and just understand if your expenses are more than your income it’s time to flip that equation. Because it’s hard to really do any significant cash flow planning if you’re negative consistently.

Andrew Busa:

Well, all right. Enough of the bad news, let’s talk about the good stuff with credit cards. Let’s talk about perks, and this is why a lot of people sign up for cards in the first place, right?

Michael Dillaire:

Yeah. So I’ll start with the basic ones too, like the convenience factors of having the credit cards. [inaudible 00:08:22] virtual wallet, immediate fraud claiming and protection, the grace period I mentioned before which essentially is a one month free loan to pay back the balance. Most importantly with credit cards too, which we haven’t mentioned yet ironically, is earning credit. But I’d say the most talked about perk of the credit cards are the rewards, usually the form of points. These points can be used for many things, whether cash back, travel, hotels, retail discounts, et cetera, et cetera.

Andrew Busa:

Right. And points, yeah talk to us more about points.

Michael Dillaire:

Yeah. So when you spend you receive points, and points are a great thing to have. Sometimes you receive them as a bonus introductory offer, spend a specific amount in a few months receive X amount of points back. Think about a free hotel stay when you decide to go away or reducing your balance through cash back, or even upgrade on your flight just because you used your credit card instead of your debit card. And I definitely want to repeat that last sentence again, just because you used your credit card instead of your debit card. And Andrew, I’m going to ask you a question now. When doing financial plans, how often would you say we budget in travel into the expenses?

Andrew Busa:

I’d say 99% of the time.

Michael Dillaire:

Exactly. So now by using one piece of plastic over another for purchases, we can help strategically reduce a big expense that we use in financial planning. And as we know from doing many financial plans, spending and expenses can really make or break a plan.

Andrew Busa:

Yeah, absolutely. That’s a really good point. Where I think when we were researching this podcast, I was surprised by this actually where using credit in the right way can help your spending actually be more efficient and save you money.

Michael Dillaire:

Yeah.

Andrew Busa:

If you’re picking the right cards, we’ll get into that in the last section. But I know you had a little story about this that really drives that point home.

Michael Dillaire:

At a previous job I used to work a lot with credit cards, hence why I know you asked me to hop on this podcast.

One instance came to mind specifically. And I was sitting with a couple who was asking about a personal loan because they were just starting to plan for their wedding, and they were talking about all their expenses that came along with it and the deposits that needed to go down, venues and stuff. Instead of a loan, I showed them a couple of credit cards that I thought would be perfect for them. And both of these cards had an introductory offer to spend X amount and receive points, but one of the cards also had an introductory offer of 0% APR for a year and a half. So the card without 0% APR, I recommended they spend X amount alone to get the bonus points and then just pay off the balance as they normally would so they don’t get charged the interest. But the rest of their spending I recommended they put on the card with 0% APR and strictly pay the minimum payment until after the wedding.

Michael Dillaire:

Long story short, they received both introductory offers, paid the balance on the 0% APR card with the money they received as gifts for their wedding within that year and a half promotion time, and then used all of the bonus points they received for their free travel for their honeymoon. So points are awesome. Instead of paying a loan with interest, they were charged zero interest and got a free honeymoon flight.

Andrew Busa:

You did some fancy footwork. Were you invited to the wedding?

Michael Dillaire:

I probably should have been, but no I was not invited.

Andrew Busa:

Okay. Well, I mean maybe in the future. But no I mean that really shows the power of doing this the right way.

Andrew Busa:

How many cards is too many? Is there a line in your head where it just becomes unwieldy to just get these introductory offers?

Michael Dillaire:

Yeah. A question we see a lot of, and the answer is it’s different for everyone. Usually, we’d say have more than one card, but not so many where you aren’t using them. And I wouldn’t recommend getting cards just for the offer, but maybe get a blend of a few cards. So often households will have a variation of credit cards to maximize their spending. For example, 2% cash back on everything paired to the 5% on a specific retail, and then a 3% on food and travel or two other categories. The reason for this is if you just had say the 2% cash back on all purchases, you’re leaving a lot of rewards on the table. If you spend a lot on say food, you get that extra 1% for having a second card.

Andrew Busa:

Right. So in a lot of ways really credit cards handled the right way helps you to be more thoughtful about your spending. Which, as you mentioned, this is an enormous part of your financial plan is understanding your spending, make sure you’re spending the right way. I mean my takeaway from this section, perks are incredible if used the right way. Just watch out for carrying balances like we mentioned in the previous section.

Let’s transition over to kind of how all of this is sort of playing into building your credit score over time. And that was a perk that you mentioned previously as well is building credit, credit history over time. So talk a little bit more about your credit score, why that’s important, what to know here.

Michael Dillaire:

Sure. Credit scores are comprised based on many factors. Having multiple variations of credit helps you build your credit score. So like a few credit cards, maybe some student loans, a car loan, mortgage, et cetera types of credit out there. But there are other factors that affect your credit score as well, such as length of credit history, available credit that you have, any current balances, any late payments, are there recent credit polls. All of these tied together primarily make up your credit score, which is ranged from between 300 points to 850 points. And a good credit score they would say is about 690 to 720, and then anything 720 or above they would consider excellent.

Andrew Busa:

Right. I’m thinking the importance of a good credit score, why do you think it’s important to really cultivate that through your life?

Michael Dillaire:

Yeah. Credit follows you like an educational transcript for young students.

Andrew Busa:

That’s scary.

Michael Dillaire:

For the most part, the point of the score is correlated to who lends you money. The higher the score, the higher the chance a lender will loan you money for those purchases that most people will do in their life, home and car. The score helps dictate what your interest percentage will be, also upon the willingness for them to lend you money. So a fraction of a percent off of your interest rate and your mortgage could mean thousands of dollars in savings.

Andrew Busa:

That’s huge. And I don’t know if you’d confirm this or not, anecdotally it seems I’ve heard it’s a lot harder to bring your credit score back up once it’s dinged from major things over time. So I guess all that’s to say is just protect your credit score. Make sure you do the right things over time to keep it healthy.

Michael Dillaire:

Yeah. And the convenience factor I mentioned before too, nowadays you can check your credit score without any ding or a lower of the percentages. So make sure that nothing went wrong too.

Andrew Busa:

Yeah, that’s a good point. So I’m going to do a quick rant on Credit Karma to that point. This is a free app that anybody can download and you can get an immediate view of your credit score at any time. And it helps you also understand how your credit score is being calculated, what you can do to improve your score. Like you mentioned, encourages you to look at your free credit report every year from one of the three major reporting companies, those would be Equifax, Experian, and TransUnion. Like you said there, what we’re looking for are any mistakes on your credit report. So they’re not going to correct it if it’s left alone, that’s up to you to get in touch with them and correct those mistakes. Also it’s helpful if there’re any fraud attempts, you can keep track of those. I mean there’s a whole lot of benefits for why you should have this sort of app on your phone to track your credit over time.

Michael Dillaire:

Yeah, absolutely.

Andrew Busa:

All right. Well, let’s bring this home and think about choosing the right card. Because I know I get offers in the mail all the time about how I qualified for a new card and all the rest of that. How do you know what card is right for you?

Michael Dillaire:

Yeah. So with credit cards before you make a choice, I’d say definitely look through your spending. Why would you apply for a card that gives you cash back on gas, but you live in New York city and don’t drive? Or if your local airport doesn’t fly a specific airline, why would you have that airline’s credit card?

Andrew Busa:

Right.

Michael Dillaire:

The perfect card for you is tailored directly to your spending, or when you have a big purchase coming up. And points aside too, some cards even come into play when you need to establish or rebuild credit with secured cards or student cards. And there’s a saying out there too that bad credit is better than no credit, so establishing your credit history as young as possible can be beneficial.

Andrew Busa:

Yeah. Yeah. I like that. When you talk about factors that play into your credit score, that credit history is one of the biggest factors. So absolutely you start that young, start to build credit in the right way, that pays dividends later down the road. Just like investing early on.

We’ve covered five large topics here today with regard to credit. We’ve talked about the basics, obviously. We hit on interest rates, APR, the idea of carrying balances. We’ve talked about perks and how to get the most out of those. Managing your credit score and understanding it. And then finally, like you said, choosing a card that’s right for you. I guess if we were going to end with a concluding thought, how big picture do you see all of this fitting into someone’s larger financial plan? I know we touched on it as we went through, but if you just had final couple of thoughts for the listeners.

Michael Dillaire:

Credit cards have great perks, and I’m sure we highlighted most of them today. But ultimately the goal is to strategically use them for the rewards in the present, saving you money now and using the points for travel, et cetera, et cetera, but ultimately the goal is to help raise your credit score for the real savings of the lowered interest rates on those big purchases in the future I know we mentioned before.

Andrew Busa:

Yep.

Michael Dillaire:

So tying back to your plans and financial planning. Saving money, it can be as just as beneficial as more income coming in at the end of the day.

Andrew Busa:

That’s a really good point. You talk about taking advantage of a 401(k) match at a company for example, if you don’t you’re leaving money on the table. I’m almost kind of thinking about this in the same way where, like you said, if you’re spending money at a certain store all the time and that’s never going to change, you’re kind of leaving money on the table if you don’t potentially use that card where you could get more rewards, 3% or 5% back.

Michael Dillaire:

Yeah, exactly.

Andrew Busa:

So this was great, actually. I feel like we covered a lot of ground in a short amount of time. Maybe we’ll come back with more episodes on different types of credit. Thanks, Mike, for your first episode, I hope you had a good time.

Michael Dillaire:

Yeah. Had a lot of fun. Hope to be here again.

Andrew Busa:

Absolutely. Well this has been Mike and Andrew from Adviser Investments thanking you for listening to The Adviser You Can Talk To Podcast. If you enjoyed this conversation please subscribe and review our show, and you can also check us out at www.adviserinvestments.com/podcast. Your feedback is always welcome. If you have any questions or topics that you want us to explore, please email us at info@adviserinvestments.com. Thanks for listening.