Credit card sign-up bonuses and ongoing rewards can provide hundreds — even thousands — in value, redeemable as cash back, travel and more. Those rewards offer something extra every time you spend, sweetening the deal on purchases you’d have to make anyway. But spending beyond your budget to meet a sign-up bonus or using rewards earning rates to justify an unnecessary purchase can set you up for credit card debt.
Earning rewards and paying off your balances before interest charges apply is a solid approach. It’s when interest charges and revolving balances enter the picture that it becomes a problem. Let’s do the math on how credit card debt stacks up against rewards and see how you can earn rewards without racking up massive debt.
[Read: Best Rewards Credit Cards.]
Overspending and Interest vs. Rewards
Earning rewards gives you an incentive to spend on your credit card and could push you to spend more than necessary. Chasing sign-up bonuses could pressure your budget if a minimum spending requirement outpaces what you’d typically spend.
Rewards can feel like a game, says Michael Rodriguez, certified financial planner with Equanimity Wealth, a fee-only financial planning firm. “But for a lot of people, that mindset pushes spending beyond what they’d normally do,” he says. “I’ve seen folks justify purchases they wouldn’t make with cash, just because they’re chasing miles or cash back.”
Spending beyond your budget — even to meet a coveted sign-up bonus requirement — puts you at risk of accumulating debt. If you can’t pay off your balance in full each statement period, you’ll have to pay interest unless you have a card that offers a 0% introductory annual percentage rate.
Paying interest almost instantly erases rewards value, says Caleb Wood-Daggett, founder and financial advisor at Commonwealth Strategy Advisors, a retirement planning firm for federal employees. “Earning 2% in cash back can’t compete with 24% APR,” he says.
Warning signs you’re prioritizing rewards over financial stability include:
— Carrying a balance to earn a sign-up bonus
— Opening multiple cards and not paying them off each month
— Using points to justify unnecessary purchases
“If you’re carrying a balance just to earn rewards, that’s the biggest sign,” says Rodriguez. “Another is feeling like you ‘have to’ spend a certain amount to hit a bonus, even if it doesn’t fit in your budget. Or if you’re using points to buy things you wouldn’t otherwise get. The rewards should be a bonus, not a reason to overspend.”
[Read: Best Cash Back Credit Cards.]
Calculating Rewards vs. Debt
Let’s say you get a new Capital One Venture Rewards Credit Card. It earns 75,000 bonus miles once you spend $4,000 on purchases within the first three months from account opening and unlimited 2 miles per dollar on every purchase. It has an annual fee of $95, and the APR is 19.99% to 29.24% (variable), based on your creditworthiness. See Rates & Fees
If you spend $4,000 in three months, you’ll earn the 75,000-mile sign-up bonus (worth at least $750) and at least another 8,000 miles from earning 2 miles per dollar (worth at least $80). That gives you a total rewards value of $830, though you could get more value if you transfer miles to Capital One’s partners.
Although you’ll get at least $830 in value out of the sign-up bonus, there’s that $4,000 balance to take care of. If you can pay it off in full, great — you’re ahead of the game. But that $830 sign-up bonus value could turn into thousands in interest charges if you can’t pay it off right away.
If you only pay $100 per month on your $4,000 balance at 24% APR, it would take almost seven years and more than $4,000 in interest charges to pay it off, far outpacing the $830 value you earned. Even if you make $250 monthly payments, it would still take almost two years and nearly $900 in interest to pay it off.
Choosing a card with a 0% introductory APR can soften the blow. If you had an 18-month 0% introductory APR on purchases, you could make that same $250 monthly payment and have the $4,000 balance paid off in 16 months. You won’t pay any interest charges by paying off the balance within the 0% introductory period.
The bottom line? It’s best to pay off your balance in full before interest charges apply, or you’ll easily wipe out the value of rewards.
[Read: Best Credit Cards.]
Earning Rewards Without Debt
Spending to earn rewards can put you in debt if you’re unprepared, but you can earn without debt if you spend within your budget and pay off balances before interest charges hit. If you’re paying interest, you’re likely losing money. Make budgeting your first rewards strategy, ensuring that rewards fit into your budget and not the other way around.
“Use your credit card as a debit card,” says Wood-Daggett. “If it’s not in the bank, don’t swipe.”
Before you pursue a sign-up bonus, consider whether the spending requirement is within your typical spending patterns. If you’d typically spend $4,000 in three months and can afford to pay off the balance each month, that’s a safe option. Otherwise, you should consider a different card that fits your budget.
Follow these tips to earn rewards without debt:
— Use your credit card like a debit card, paying it off each statement period.
— Only spend what’s in your checking account or within your budget.
— Use cards for predictable expenses in your everyday budget, such as groceries or gas.
— Take advantage of 0% APR offers if you want to earn rewards on large purchases that you need time to pay off.
“Rewards should fit into your financial plan, not drive it,” says Rodriguez. “A good budget gives you guardrails so your credit card works for you, not the other way around.”
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When It’s Credit Card Rewards vs. Debt, Debt Always Wins originally appeared on usnews.com
