Using cash instead of using a credit card can save you from paying interest fees and help avoid the damage to your credit that occurs when you run up high balances.
On the other hand, you can also lose hundreds, or even thousands, of dollars by paying cash because of lost rewards or a lower credit score that hurts your ability to get lower interest rates on future loans. Understanding when it pays to use plastic and when to use cash will help you make the right credit decisions.
Using different types of credit can increase your score.
Calculate the Annual Interest
One of the easiest ways to determine how much you’ll save paying cash instead of using credit is to do some simple math calculations. If you put $1,000 worth of charges on your credit card and your card has an annual interest percentage rate of 20 percent, you’ll pay $200 in interest if you carry that balance for one year.
This often happens when you keep increasing your balance, make the minimum payment each month and carry balances over from year to year. If your card has an annual fee, add that to your $200 cost to use the card.
Calculate Monthly Interest
If you’ll carry a balance for less than a year, or pay off part of your balance before it reaches one year, you can make some approximate estimates by using a monthly interest calculation. Let’s say you buy a $1,000 computer on January 1, carry that balance for exactly three months, and then pay the full amount off.
If you had a 20 percent annual percentage interest rate, you divide $200 by 12 months to get approximately $17 worth of interest per month. If you had paid cash, you would have saved $17 times three, or roughly $50.
Paying Cash Can Lose You Money
If you can get a credit card that provides rewards, such as free airline points, you can actually lose money by using cash. If you will make enough charges to earn at least a one-way airline ticket and you can pay off your monthly balance each month, you’ll earn the ticket and pay no interest.
Depending on how much you charge and what rewards your card offers, you can save hundreds of dollars on purchases such as gas, hotel rooms, air travel or a new car. You can even get a cash-back bonus when you use some credit cards, even if you pay off your balance each month.
Using Cash Can Cause Higher Interest Rates
The higher your credit score, the lower the interest you can get on credit such as a car loan or mortgage. A low credit score can also hurt your chances from getting a credit card or student loan.
One way to raise your credit score is to use different credit products, even if you don’t need to, and make your payments on time. Open an installment account, which is credit that requires you to pay a set fee each month. You might buy a computer from a store this way, or get a car loan.
Get a revolving credit product, such as a credit card. Revolving credit payments change each month, based on your balance. While you will have to pay interest on an installment purchase or credit card balance, you will build a higher credit score, which can save you thousands, or even tens of thousands, of dollars on future credit use.
For example, a high credit score can help you get a new credit card that allows you to transfer a large balance at 0 percent interest for 18 months, or get a lower mortgage rate that lowers your interest payments for decades.