Credit cards and cash are often interchangeable, but you can get into serious financial trouble if you treat credit cards as a form of money.
Credit cards can have a strange effect on people. When you’re earning S$3,000 a month, and receive a cash rebate credit card with a S$10,000 limit, putting that card in your wallet can make you feel like you’re sitting on pile of money waiting to be spent. (True story, by the way.)
But you shouldn’t count credit cards as part of your wealth, and making the mistake of doing so can get you into serious financial trouble. Here are 3 reasons why.
Credit Cards Are Not Money
First off, credit cards are not considered money as they do not have the same characteristics.
Money is an asset that is highly liquid – it can be readily converted into cash (for example, when you withdraw cash from the ATM), or be used as cash.
When you pay S$5 in cash to that chicken rice stall for your lunch, the stall owner can take that same S$5 and go buy a new chopper.
But, if you pay for your meal using a credit card, there’s no S$5 note that has physically changed hands. The stall owner cannot immediately go out and buy a new chopper; he has to wait for his bank to credit the payment to his account.
When you pay for a restaurant meal using a dining credit card, your credit card company lends you the funds needed to settle your bill. You then pay back your credit card company at a later date.
Also, the amount furnished by your credit card company for your purchases is not money. It is an obligation for you to pay it back later.
Let’s say your friend owes you S$20, and you owe S$10 on your credit card. Your credit card company cannot go to your friend to collect the S$10 you owe.
Your obligation is not transferable (i.e., lacks liquidity) and therefore, also cannot be considered money.
Credit Cards Incur Interest Charges
The credit limit on your credit card is an indication of the maximum amount of money the issuer is willing to loan you, and it is put there to facilitate your use of the card.
Your credit limit is pre-approved – which means you are free to put payments on your card, up to that amount. Without this pre-approved amount, you’d have to call up your bank every time you wanted to charge a purchase to your card.
Credit cards are as convenient as cash, especially for large purchases. This can make it easy to think about credit cards as money, possibly because of mental accounting.
A cognitive bias, mental accounting is the tendency for human beings to assign different uses to money coming from different sources.
A credit card can seem like a separate account containing a certain amount of funds. This can cause you to treat credit cards differently than you do your regular bank account.
Let’s say for example you want to go for a holiday, but do not have enough savings to do so. You might be hesitant to ask for an advance from your employer, but you may not have any qualms about using your credit card to pay for the shortfall.
The latter option seems more acceptable, even though you will incur a rollover balance and be subject to interest charges.
In contrast, you do not incur interest for taking an advance from your boss.
Credit Cards Are A Temporary Loan
The most important distinction between money and credit cards is this: the former is an asset, the latter is a possible liability.
Money is an asset because it adds to your net worth. Having money doesn’t disadvantage you in any way. (Well, except for taxes.)
Credit cards, on the other hand, is a type of loan that is designed to facilitate your payments. If you carry a balance – i.e, is unable to pay off your bill in full – you are in effect taking on a loan, and one with pretty high interest to boot.
Taking on a loan also means you get into debt, and debt subtracts from your net worth. This is why credit cards can potentially be a liability.
What if you use your cards responsibly? Well, the credit limit you have been pre-approved to use is not money that you own. Therefore, credit cards cannot be considered as assets.
Credit Cards Can Be Better Than Cash
By now, you understand why you shouldn’t treat credit cards as money. But if you use credit cards the right way, they can be better than cash.
The most attractive thing about credit cards shouldn’t be their credit limits, but the many rewards, privileges and benefits they give you.
From air miles and reward points, to exclusive discounts and cash rebates, there are many ways credit cards help you save money, or gives you a bigger bang for your buck.
Use your credit cards responsibly and wisely, and maintain a balance of zero across all your cards. You’ll see how credit cards can be better than cash.