How I Use Credit Wisely

Last week, economist Tim Harford wrote an article for Forbes discussing the behavioral economics behind using credit. It is Harford’s premise that the human brian is wired for immediate gratification especially if we can postpone the consequences. It is for that reason, that we are unable to properly comprehend the complex financial instruments that have driven the current economic crisis. Per Harford,

An indication of this comes from looking at savings rates over time and compared with other countries. Looking at the G-8–eight of the world’s leading economies–the two countries with the biggest and most exciting range of retail financial products, the U.S. and the U.K., have also been the ones with the lowest savings rates. Countries like Japan and Italy, with a back-to-basics range of products, have higher savings rates.

With today’s negative economic climate portraying consumer credit in an unfavorable light, it is easy to forget the benefits of responsible credit use. I have discussed at length on this blog how my irrational spending hurt me while in college and how I pulled myself through, but I haven’t told the complementing story about the everyday benefits of using credit. This is mostly attributed to my need to put a few months of spending under my belt. I have had my first post-repayment credit card for nine months and have found the niche of how to use it.

Without credit, my spending was limited to the cash I had on hand from biweekly paychecks. This was an excellent lesson in budgeting because it put me in the habit of spending only what I could afford, and not overextending myself with easy money from credit cards, loans, or other consumer debt. In a perfect world, my core living expenses such as rent, utility bills, and student loan payments would match up perfectly to my paychecks. But paychecks typically come in biweekly intervals while core living expenses are billed monthly. For most months, my income would exceed my core expenses providing me with marginal leftover cash for other living expenses and luxuries such as groceries, nights out with friends, new clothes, and a modest savings. But some months, my expenses would exceed my income, requiring me to cut back on other living expenses and luxuries, or liquidate my savings. With this formula, I was spinning my wheels.

With credit, my ability to pay core living expenses, other living expenses, and luxuries has drastically changed and allowed me to save at a higher rate than I could previously imagine. It began with a change in my philosophy of how I pay everything but core living expenses. Previously, they would be paid with cash on hand through using my bank debit card which required me to exercise absolute precision. If it was a month where my extra cash would be thin, I would have to cut back — which meant I would have to eat on an extreme budget. But now, I set a monthly budget for how much I want to spend on those expenses and put all of them on my credit card. Instead of worrying about thin margins, I can pay those expenses on a monthly basis as part of my credit card bill. In addition, I use an online financial manager called Geezeo to track and categorize all of my credit card spending.

Having credit allows me to put large chunks of money every month into an interest baring savings account. What this does is change the mentality of me spinning my wheels without getting ahead to wow, I am saving a LOT of money. And as my savings account continues to grow, I challenge myself to spend thriftier on a monthly basis. But it is important to note that this philosophy only works if you pay your credit card bill in full every month. If you don’t, interest charges from your credit card company will more than negate any interest on your savings account.