Credit cards can be a powerful tool in the world of personal finance but like everything, they’re not without risk. First and foremost, if you carry a balance on a credit card and incur interest, any rewards or benefits you earn are almost certainly negated. That said, if you can use credit cards responsibly, they are a powerful tool to help manage your finances. 

Benefits of credit cards

Building Credit History

Building a credit history is crucial to getting favorable interest rates on loans, such as mortgages. Without a credit history, a lender has no basis to give a consumer their best rate. A credit card is easy to apply for, and on-time payments help boost your credit score. Over time, responsible use of credit cards can help lower the interest rates lenders offer you.

Purchase protection

Credit cards have an extra layer of purchase protection relative to debit cards. Often payment information can get stolen from consumers at no fault of their own. Using a credit card with a merchant rather than a debit card helps prevent loss and liability for fraudulent purchases.

Cash Back

The standard cash-back rate for a no-annual-fee credit card is 2% regardless of category. Since many merchants don’t charge extra for credit cards since it’s against their agreement with payment processors, by using a credit card, you should be getting at least 2% off every purchase you make. While there are exceptions to this, namely paying debts such as mortgages or buying gasoline, an extra 2% off your purchases can add up over time. To put this in perspective, if you make a weekly purchase with a 2% cash-back credit card, the cash-back covers a week of that expense each year.

Perks

Credit cards can often be excellent for extended purchase protection, airport lounge access, and rental car insurance (be sure to see if it is primary or secondary insurance, as the latter only kicks in after your personal insurance is exhausted). If these are things you already pay for, credit cards can help you get them for a reduced price.

Tax Arbitrage on Points

Often credit card points and miles are considered tax-free if associated with purchases. However, referral bonuses can be taxed, and credit card companies will send you a 1099 if you received points or miles as a bonus. That being said, the valuation used for the 1099 could be under the current market value of the the points or miles. This can effectively be an arbitrage since the value received exceeds the taxable value, but be warned, points and miles aren’t quite are fungible as cash. 

Risks

Interest

Since a credit card is a revolving line of credit, and unsecured by any collateral, interest rates are significantly higher than other loans. Forbes tracks interest rates on credit cards, and the average was 28.90% as of October 2024 (source: forbes.com/advisor/credit-cards/average-credit-card-interest-rate). The good news is that as long as you don’t carry a balance, you won’t get charged interest. If you are carrying a balance, you might want to check what that costs you.  While some credit cards are specifically designed as balance transfer cards that have a 0% APR for a limited time, spending money on credit cards you can’t pay is rarely a sound strategy.

Rewards Don’t Compound

While points or miles might be as good as cash to you, until you redeem them, you’re effectively placing an asset in a 0% interest rate account. This is especially challenging if your card is earning points or miles rather than cash back. Often consumers will save miles for years before using them for a trip. Couple that with the fact that rewards have minimum redemption limits and can expire. Pay attention to accumulating points, and plan to use them regularly.

The Value of Points is Elusive

Another issue with points and miles is that the value can fluctuate drastically depending on when and where they are redeemed. The trip you want to take might not maximize the value of the points you are using. For instance, credit card points from major issuers can be valued at an average exceeding 2 cents per point. However, if you typically redeem points for domestic travel, do you still get 2 cents per point? Does the price on a credit card’s travel portal match a direct price with an airline? Does the value hold during holidays and peak vacation times?

Gamification of Points

Often travel cards come with some great perks and credits. Just remember that credit card companies partner with merchants to provide these perks to incentivize you to spend more money. For example, you might find yourself spending money on a particular meal delivery service platform just because you have monthly credits. If your card has an annual fee, having this “inorganic spend” shouldn’t fully discount the fee by that amount. In other words, unless you were already spending money at a specific merchant every month, getting credit to that merchant isn’t the same as simply having your annual fee reduced by that amount.

Terms and Benefits Can Change

Credit card companies expect some attrition when they change benefits and hike annual fees. However, they also count on consumers who tolerate these changes or simply don’t notice. Remember to pay attention to your credit card's terms and conditions. If the annual fee increases and the current benefits are no longer worth it, see if you can downgrade to a no-annual-fee card to keep the credit history open. 

Summary

Overall, credit cards can be a great tool to complement a sound financial strategy. Just be mindful that they are designed by their issuers to encourage spending. While cash back and points can be a nice bonus, credit cards aren’t a vehicle to create wealth.