Credit cards get a bad wrap. Too many people claim credit cards are evil, when nothing is further from the truth. Making such a broad statement is the same as saying that guns are evil. Neither of these is evil, and when used correctly, they can be useful tools. The key is learning how to use them effectively.
How does that relate to becoming a millionaire? Glad you asked, and before we go much further, I’ll answer your the question I asked in the title: No, you can’t use credit cards to become a millionaire. But you can use credit cards as part of a balanced financial plan, and depending on your financial habits, using credit cards can actually smooth your path to becoming a millionaire.
The path to millionaire status
Let’s take a look at two things: how to become a millionaire, and how to use credit cards effectively. Once we examine these two tenants of personal finance, we can investigate how using credit cards can help you on your path to becoming a millionaire.
1). There isn’t a trick to becoming a millionaire. You simply need to spend less than you earn, save and invest the difference, and repeat the process. Yes, that is a simplified approach and it takes time,and diligence, but there is no magic formula.
2). The key to effective credit card use: With one major exception, there is only one way I recommend using a credit card, and that is by paying off your balance in full each month. If you aren’t planning on using your credit card like a debit card (only using it when you have the money to cover the purchase in your checking account), then you shouldn’t use a credit card at all. This should be a rule to live by – with one exception – using your credit card to help you get out of debt.
Get out of debt first
You should almost always get out of debt before focusing on investing. And if you are in debt, using a balance transfer credit card may be a good way to reduce your interest rates to 0% to help you repay your debt more quickly.
Let’s take a quick look at how this works: Let’s assume for a minute that you have $10,000 in credit card debt at 20% interest. That means over the course of the year, you will pay approximately $2,000 in interest payments if you are only paying the minimum on your credit card balance. You will never become wealthy if you are sending that kind of money to credit card companies in the form of interest payments. $2,000 can go a long way toward building your wealth.
The goal, if you want to become wealthy, is to get out of debt as quickly as possible. So if your minimum monthly payment on $10,000 in credit card debt is $100, but most of that goes to cover interest payments, you are wasting time and money. If you can reduce the interest rate to 0%, then 100% of your payment goes toward reducing the principal on your credit card debt, reducing the amount of time and money it takes to get rid of your credit card debt once and for all.
Once you retire your credit card debt, you should then focus on investing. Why not invest while you are still in credit card debt? Because you most likely won’t be able to beat the guaranteed return on investment that you get when you pay extra on your loans. Imagine earning a guaranteed 20% interest rate on your investments – that is what you will earn when you prepay your credit cards!
There is an exception – you may consider investing in your 401k if you have a company match because an employer match is essentially free money which you don’t want to pass up. Other than that, it is usually best to wait until you are debt free before investing.
Credit cards can actually help you with your investing. How? There are a couple ways, but basically, if you use a cash back credit card, you can earn some serious cash back over the course of the year. My wife and I recently moved into a new home, and through regular spending we have earned close to $1,000 cash back this year. Granted, we have had a few major purchases due to the new house, but this is money we would have spent anyway, so this was cash we can use to open an IRA, fund our daughter’s college savings account, etc. Fidelity also offers an excellent cash rewards credit card which pays 2% cash back and which you can link to your Fidelity brokerage account. This makes it easy to put your cash back to work for you in the long term, and not just fritter it away on random purchases.
Credit cards won’t make you rich, but they can be part of a balanced financial plan. I’m not going to try and convince you that you will become a millionaire by using credit cards. But I will tell you that using credit cards can be wise when you use them properly and apply their benefits to your financial situation.