Many people I know struggle to maintain their savings while running up or maintaining credit card balances to keep money in the bank. They’re following the age-old advice of building savings before investing in new projects, a house, or a business, but end up paying for it through exorbitant credit card interest rates.
Here are the problems with that strategy. Banks currently pay .1% or less on savings accounts, but credit card companies charge 18-36% per year in interest on balances carried over more than 30 days. So if you carried a credit card balance of $100 at 18% it would cost you $18 over one year. At .1% annual interest on your savings, you would need $18,000 in savings to offset that $18 in interest. Also, the interest on your savings is taxable, but the interest you pay on your credit card is not deductible. In other words, you’re paying twice—once via tax on your savings and then again through a smaller tax refund because you can’t deduct your interest payments.
But if you pay your credit card off every month you don’t pay any interest AND banks will raise your credit limit while offering points equal to 1-2% of your spending. These incentives are in place because they want you to build up a balance and pay interest on it, but managed correctly, they can help you build strong credit and keep money in the bank.
Let’s look at two cases to examine smart credit and savings practices.
First, a business saving for a new office has $10,000 in the bank and a credit card with a $3,500 limit and a $3,000 balance. The credit card pays 1.5% cashback on purchases. If they use the credit card consistently and maintain the balance month over month so they can increase their savings, they pay $540 in interest, get about $90 in cash back (on $6,000 a year in new purchases) and earn $10 on savings. So net, it costs them about $446 per year on their net worth of $7,000 ($10,000 savings less $3,000 credit card balance).
Second, another business across the street also has a $7,000 net worth, but has chosen to keep $7,000 in savings and pay off their $3,000 credit card debt entirely. They also use their credit card for $3,000 in necessities they would otherwise pay cash for and pay it off every month. At the end of the year they have made $7 on savings, paid no interest on their credit card, and have earned $540 in cashback on their purchases, so they have made $547 and the credit card company has probably increased their credit limit to $5,000.
Not only has the second business made $993 more than the first ($547 plus the $446 in net costs their neighbor paid but they avoided), but they now have substantially more resources. Their resources include the credit line increase, an improved credit rating, and $993 more than their neighbor. For simplicity’s sake, the examples above don’t include additional savings deposits both businesses would likely make over the course of a year, but the end result would be similar.
As you can see, it pays to pay off all credit card debt before beginning to save seriously for a new project, office, or emergencies. Because of the uneven returns and fees for savings and credit card accounts, a savvy credit strategy can put you ahead of your goals, both personally and professionally.
Banks count on their customers’ general lack of knowledge regarding interest rates to increase their profit margins. Use these credit and savings practices to beat them at their own game and earn more money for your business, not theirs.
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