When I was only 16 years old my father had me get my first ever credit card. It was nothing fancy, just a standard rewards card with Bank of America. It had a credit limit of $3000. On the day that he gave it to me my dad gave me very clear instructions: this card was to be used to pay for gas only. I had recently gotten my first job and a driver’s license, and would be driving on a regular basis each day. There was one more rule in addition to the spending restriction: I was to pay off the entire balance of this card each and every month with no exceptions.
At the time I did not fully recognize what my father was doing. I did not understand how credit cards work, and certainly wasn’t familiar with the problems that they can cause for someone. Additionally, I knew nothing about credit in general and how a rewards card works. As far as I was concerned this was just something my dad set up so I would always have gas money. It would be years before I realized that he was helping me take my first steps towards building credit. Continue to read below to learn how I went from this first step to making my rules for using credit cards to build credit and start a great passive income stream!
Credit Cards Are The Best Way To Start Building Credit (If You Follow Certain Rules)
It was about four years later, when I was halfway through college, when I first looked at my credit score. When I first did so I immediately noticed that my score fell somewhere between the ‘Good’ and ‘Great’ range. I read further and discovered that this was principally due to the age of a credit account that had an excellent payment history. It didn’t take long to realize what this account was: my first credit card. I would only go on to improve my credit score from there as I started my adult life, paid off debt, and utilized more lines of credit.
The reality is that for a young person a credit card is the single best way to begin building a credit history and creating a credit score that will make life much easier (and cheaper) later on. Your credit score will determine how much credit is available to you, thus affecting how much flexibility you have in the event of a financial emergency. It will also determine what interest rates you have on loans from an auto loan to your mortgage. In other words, having poor credit can get very expensive. With this in mind, you should do everything you can to make your credit as pristine as possible, and your credit card habits can either make or break it.
Unfortunately, the sad truth is that my fellow millennials have not fully caught on to this lesson. In fact, credit card debt is a huge weight on the finances of young people today. Almost 1 in every 3 millennials today has a maxed out credit card, and 48% of them carry a balance month over month. These are the exact opposite of what you need to be doing with your cards if you want to use them appropriately. To use your credit card the right way and start building good credit you only need to follow these two rules.
Credit Card Rule # 1: Never carry over a balance month over month.
This is both the simplest thing to do and also the most difficult. It requires you to look at a credit limit in the thousands of dollars and then tell yourself that it’s not really yours. This is compounded by the fact that credit card companies have no problem whatsoever with you carrying over a balance, it is after all how they make money. The minimum due that they will put on your monthly bill will usually only be a percentage of your actual balance, and the rest will generate interest that will compound what you actually owe. In other words, you are being charged for the debt that you don’t pay off each month.
This is easily avoided by simply paying off your credit card balance in full when your bill is due. That way you are not generating a single dime on interest and you are only paying back what you spend. It becomes difficult when you think of a credit card as a way to purchase things that you either cannot afford or can’t afford yet. Too many people use credit cards for reckless spending or as a replacement for an emergency fund, and the costs get higher and higher as your balance grows.
The way I address this is by using my credit card solely for items that are included in my monthly budget. That way I never spend more than what I expect to receive in income. Basically I’m just using my credit card instead of my debit, so that I’m paying for the things I was already going to buy anyway while doing so in a way that generates a good credit history. To this day I have followed this method and never once carried a balance that generated interest.
Credit Card Rule # 2: Don’t have more credit cards than you need.
Once you enter the adult world there’s one thing that will become a regular occurrence: credit card offers. I don’t think a single week has gone by since I turned 21 where I haven’t received at least one in the mail. These can be very tempting, especially when you get an offer in the mail approving you for some insanely high credit limit. They may even try to sweeten the pot by offering cash rewards (offering you $100 if you spend $1000 in the first two months, etc) or waiving their first annual fee. These offers should mostly be file in one place: the shredder.
I know several people who have anywhere from 4-6 credit card to their name. When I asked one of my friends why he needed so many, the response I got was that it was a great way to have a higher cumulative credit limit, and that the cash rewards he was offered were too good to turn down. These were very poor reasons to get so many cards. Firstly, if you’ve followed the first credit card rule consistently you will likely not have to worry about getting the highest credit limit possible. Secondly, each credit card you has the potential to hurt your credit score. The bottom line is that you should never get more credit cards than you need. I personally use only a few based on the rewards that I am specifically targeting, which brings me to my next credit card topic…..
You Can Use Credit Cards to Generate Passive Income
My wife and I are coming to our third Christmas as a married couple. This year it’s even more exciting because our daughter will be 1 year old, so we plan on showering her with toys, books and cute outfits come Christmas Morning. While Christmas budgeting may be a stressful time for some people, this is not the case for us. That’s because we have never once spent money from our actual paychecks to pay for Christmas gifts, decorations or cards. We write our annual Christmas budget based solely on the passive income we get from our credit cards.
For those who do not know, passive income is money that you make with little or no effort. This can take the form of investment income, money you make from a property you rent to others, etc. The first passive income stream I ever made was with my credit cards.
I did not know until after I graduated from college that you can actually make money off of your credit card spending. Do you remember that rewards card from my father that I told you about? One day I was logged on to my online account and I noticed a hyperlink calls ‘Claim Your Rewards’. I clicked on it and was brought to a page that said I had a cash rewards balance of $150! This discovery was very exciting for me, especially since I had no idea that I had this money just waiting for me to get it. I spent the next several days researching everything I could about credit card rewards programs.
What I learned was that there are credit cards out there that offer a huge range of very lucrative rewards programs! Most of these programs fell into the range of travel rewards or cash back programs. The travel rewards programs are pretty simple, you get points based on the amount of money you spend that can later be redeemed for plane tickets, hotel stays, etc. Cash rewards programs pay you back a percentage of what you spend.
As newlyweds with a child on the way, we decided to focus on building as much passive income as possible to supplement our own salaried. It’s pretty difficult to travel with a newborn and our relatives all live relatively close by. Therefore, we focused on getting credit cards that had the best cash back offers. Right now we get a little over 1.5% cash back on everything we spend throughout the year.
Why I Love Cash Back Credit Cards
What I particularly love about cash back credit cards is that you can make money with expenses that you would have already had anyway. I get a percentage back from groceries, gas, eating out, and anything else that takes credit cards. The only things I don’t get cash back on are expenses that don’t take credit card payments, such as certain monthly utilities.
One of my more exciting discoveries was using my cash back cards to pay rent! Most rental companies use their websites to collect monthly rent payments from their tenants. If yours allows it and doesn’t charge extra fees, then you should use this to generate some income for yourself. If you pay 850.00 in rent and pay it using a credit card that offers you 1% cash back on all purchases, that’s $102 a year!
There really is no limit to the many different ways that you can use cash back to make money. Last year I made $300 from a rewards program and I’m on track to get $500 this year. If you’re someone who’s looking to start building passive income as you work your way towards financial independence, then this is a great first step.
This was a general overview of the two reasons I love credit cards: building credit and passive income. I hope you enjoyed reading it!