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When it comes to cash versus credit, people have some pretty strong opinions. Some eschew cash completely, finding it to be a hassle, environmentally unfriendly or just plan outdated. Others don't even have — or trust — a credit card to their name. (Millennials in particular fall into this no-credit category; just 33% own plastic.)
But basic preferences aside, this decision can actually have a significant impact on your finances. Financial planner Matt Shapiro, CFP®, breaks down when you should use credit, and when cash is best.
When You Should Use Credit
You can pay off your balance in full each month. As long as you're a responsible user and don't carry a balance from month to month, there's no reason you can't use your credit card for virtually everything, says Shapiro. Be sure to research the best card for you, and be wary of annual fees and rewards that you're not getting the full value for. "Rewards can sound better on paper than in practice," Shapiro cautions. Are you really taking advantage of those perks? Look into it. And if you're spending more than usual each month solely for the extra points, definitely reevaluate your habits.
You want extra fraud protection. A big pro to credit cards is the protection they provide — like if someone gets their hands on your digits and goes on a retail bender, you won't be responsible for those fraudulent charges. (One disclaimer: Credit card companies are allowed to hold you responsible for a certain amount of the fraudulent purchases, usually the first $50.) And in the event that your wallet is stolen, your cards can be quickly cancelled, but that cash is gone for good.
You need to build your credit. Having strong credit is important whether you're applying for a car or home loan, trying to land a job or even hoping to score a date. And in order to build up a history of responsible credit use, you need to, well, use your credit. If the idea makes you uneasy, start with a card with a low limit (this will be the default for many first-time credit users anyway) and don't be afraid to call your credit card company and ask them to lower your limit if you're uncomfortable with the amount, advises Shapiro.
You're investing in your future. Sometimes you don't have the funds on hand, but need to make a purchase that will create economic value in the future, and credit may be the answer here. Shapiro gives the example of a cash-strapped college student paying for his textbooks. Putting the expense on a 0% APR card and creating a plan to pay the balance off throughout the semester may be the best option. "This is a responsible way to buy something that will boost your value as a future employee," says Shapiro. But be sure to make the payoff plan before you charge anything, so you don't get in over your head.
You need an automated spending log. Tracking your purchases is a great way to keep your spending in check, and this is made easy when you use a credit card, because they take care of it for you. And if you use your credit card company's app or website, you can always check in on your latest purchases, rather than wait for your monthly statement to arrive.
When You Should Use Cash
You have credit card debt. You can't make serious progress on your debt if you keep adding to it each month, so if you're carrying a balance, your credit cards should be off-limits until you're in the clear. And, even then, Shapiro advises using cash or a debit card for at least six months before you start incorporating credit cards again to get a handle on your spending.
You struggle to stick to a budget. You know how much you can comfortably spend each month to stay on track with your financial goals, but swiping a credit card makes it easy to ignore reality and keep on spending. If you find yourself falling into this trap, Shapiro recommends an all-cash diet. Whatever your weekly budget is, take out the funds in cash and put your credit cards in your sock drawer. Once that cash is gone, you no longer have another way to spend.
You want to be more mindful about your spending. If you think you spend more when you use your credit card instead of cash, it's probably because you do. "You're a lot more aware of spending paper money than electronic money," explains Shapiro. Without the emotional attachment associated with spending cash, the purchases can really pile up. But when you're about to part with your last 20, you may decide you really don't need another lipstick. Budget: 1; Impulse Buys: 0.
It's a question you've heard a thousand times at registers and by waitstaff, but the answer shouldn't always be taken lightly. The smartest choice for your finances depends on your overall spending habits. If you trust yourself to pay off your balances each month — and have the flawless credit history to back it up — then go ahead and charge it. There's no reason why you can't use credit for everything and take advantage of the rewards and added security benefit.
However, if you're in debt and struggle to stick to a budget, credit can enable your bad habits. Cash, on the other hand, can make you more mindful of what you're buying each month.
Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, CFP® (with plaque design) and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board's initial and ongoing certification requirements.