Dubai: Credit card reward programs come with a seemingly endless variety of perks and points systems, but for some of those who rush into the credit card rewards game, the repercussions can be long-lasting.
While credit cards are fantastic for earning rewards, the rewards are quickly cancelled out, for example, if you are paying a high interest rate on the balance. Carrying a balance on multiple credit cards can be challenging if, regardless of your repayment efforts, you don’t seem to make any progress.
Also, some cards charge hundreds of dirhams in annual fees but come with a plethora of perks like free upgrades at hotels, access to airport lounges, discounts on tickets. So when weighing the perks and risks of a rewards program know that an annual fee can also eat into the fairly small percentage returned.
For instance, if you're paying Dh100 a year to get a 1 per cent cash back, for example, you'll need to spend Dh10,000 to get the annual fee back. On the other hand, if you need or want that particular card and you're going to charge money on it regardless, the 1 per cent, or more, can be a nice bonus.
So the potential for falling further in debt is one of the major pitfalls of credit card rewards, and while some of your credit card debt is the result of emergency spending, it's inevitable that some of it also comes from poor planning.
Risk #1: Credit card rewards can cause you to spend more: Research
While many people who pursue credit card rewards say using credit doesn't change spending habits, some research suggests some spending habits change quite a bit. A 2008 study noted the immediacy of paying with cash affected people differently than the delayed consequences of paying with credit.
In an excerpt published in a reputed psychology journal, the argument was “the more transparent the payment outflow, the greater the aversion to spending or higher the 'pain of paying' … leading to less transparent payment modes such as credit cards and gift cards (versus cash) being more easily spent.”
In other words, credit cards dull the pain of paying. They do this by delaying the timeline in which you have to pay your bill and by allowing you to mix your purchases in a way that causes you to forget exactly what you're buying.
If you sign up for a bunch of rewards cards without knowing whether you can use them like you would cash, you may regretfully find that you're someone who overspends with credit. This can prove costly, but you can minimise damage by taking time with rewards cards and using them in moderation at first.
Risk #2: Juggling too many new cards can lead to reckless spending
One of the main drivers behind rewards card sign-ups is the initial bonuses they offer. Many cards offer hundreds of dirhams in cash back or travel credit for spending a specific amount of money within a few months (e.g. Dh3,000 in three months).
These bonuses can be lucrative, but they can also cause people to overspend to reach the required spending minimum. Juggling too many new cards at once can also leave you in a position where you have to spend more to earn each of the bonuses you're after.
If, for example, you signed up for three cards that required you to spend Dh3,000 in three months to earn the bonus, you would be on the hook for Dh9,000 in spending at once. While you could pull it off without jeopardising your financial health, there is a possibility of not.
So you're better off pursuing only one bonus at a time and making sure you can reach any spending thresholds naturally with regular purchases like groceries, fuel, insurance, and utilities. After all, buying things you don't need to earn a credit card sign-up bonus is unlikely to leave you in debt.
Risk #3: Multiple new credit card applications can hurt your credit score
Another reason to approach credit card rewards carefully is the fact that getting too many credit cards at once can actually hurt your credit score. Every credit card application will prompt the bank to raise an 'inquiry' into your credit report in order to evaluate your credit worthiness.
These inquiries or checks get listed on your credit report, and are also visible to other lenders. Multiple credit applications not only signal desperation on the borrower's part but they will also put you in a higher-risk category. This is why every additional credit inquiry will chip away at your credit score.
So new credit cards may cause credit reporting agencies to believe you are a greater risk, and they may push your score down accordingly. But as long as you're not overburdened with debt and are able to keep up with your monthly repayment schedule, you shouldn't have too much to worry about.
In addition to new credit, the length of your credit history also makes up a part of your credit score. Since getting new cards will cause the average length of your credit score to drop, this is another factor that can hurt your credit in the short-term.
Key takeaway: It takes time to build good credit habits, so choose rewards cards wisely
Why stick to just one rewards credit card if you can combine them to increase your net rewards? You can choose to use one card for one type of purchases and a completely different one for other types of purchases.
Because different cards often offer different rates of return for each spending category. By splitting your spending intelligently you are maximising your rewards by taking advantage of increased rewards on all your purchases – not just some of them. Makes logical sense doesn’t it?
But figuring out which rewards card is best for you takes time, so rushing and amassing cards doesn’t help. Experts also flag how it takes time to build positive financial habits — including the ability to use credit responsibly.
So if you jump into several rewards credit cards too soon, you might wind up in the middle of a problem you don't know how to fix. Knowing your spending habits, timing your application and negotiating to waive the annual fee are all ways you can maximise your rewards.
The best way to use credit cards is in conjunction with a monthly budget. You can charge your purchases each month to earn rewards, but you should have the cash on-hand to pay your bills since the average credit card interest rate is over 16 per cent.
It also helps to build an emergency fund you can use to cover unexpected expenses or fill the gaps if your earnings drop for any reason. If you use credit without a plan, you could live to regret it and wind up in debt for a long, long time.
