The Illusion Of Free Money

The mirage your not-so-friendly neighborhood big bank is selling you …

The first rule of personal finance is to take advantage of all the FREE-MONEY opportunities surrounding you:

· Build a lucrative side hustle based on your existing talents,

· Don’t miss out on your employer’s 401(k) match,

· Resell the old or unused items sitting around your home,

· Or even better, move your home to a lower-cost city.

And so many other hacks … which all require more context to properly fit into your unique financial life. There is one hack in particular that requires additional context to avoid the illusion of “free money.”

Who Wants The Points?

How has this question replaced “who wants to pay the bill,” at a group dinner?

Credit card rewards, whether cash back or travel points have become ingrained in our increasingly digital world. Their alluring charm makes perfect sense logically, why not receive an extra benefit for the money you are already spending?

But there are several problems with this logic …

It’s Hard To Admit, But It’s True

A small piece of hard plastic has changed us … and not for the better:

Also, per Lendingtree, over 40% of credit card holders and over 50% of active credit card users have carried a balance on their credit cards.

This means that the majority of credit card users are living beyond their means and spending money that they would otherwise be unable to spend … I can guarantee there would be consequences if you attempted to overdraw your checking account by $7k.

But What About The Rewards …

Reviewing Nerdwallet’s best cash-back credit cards as of November 2023:

Based on a full review of this list, cash-back rewards generally fall between 1% to 5%. Let’s assume the cash back rewards are 2% to 2.5% for the average credit card user, this means that the average user received approximately $180 cash back on their average balance of $7k.

Quick caveat, this benefit is likely overstated:

· All credit cards do not receive rewards,

· Nerdwallet’s listing of the best cards, likely overstates the average cash back rewards received,

· This listing excludes travel rewards, which may be less valuable than the average cash-back reward,

· It is likely that credit card users’ spending does not maximize the available benefits.

But even with this aggressive reward estimate, the “free money” math does not work out for the average credit card user.

Where Free Money Becomes Too Good To Be True

You should always be skeptical of anything free, especially when it is coming from a large, profit-motivated bank. Not only is “free money” from credit card rewards too good to be true, it is also quite dangerous.

You need to move beyond the exciting marketing to the boring math. Specifically, the interest rate on credit card debt:

This average interest rate is just over 2% interest per month, which means that you reach your break-even point in only one month of interest accruing, even with an aggressive cash-back reward.

Should You Avoid Credit Card Rewards?

You need to answer this question with another question … can you pay off your credit card immediately?

If the answer is no, then the math does not work out in your favor. There may be reasons to consider using a credit card, e.g., building a credit history, but please do not expect to make any money until you can pay off your debts immediately.

Please reach out to [email protected] with any questions or suggestions for other personal finance topics to cover.