Overview
Credit cards are an incredible tool for earning hyper-valuable points and miles that you can redeem for thousands of dollars in travel. We spend all our time building guides and other handy bits-and-bobs to help you thrive in this space, but there’s one oft-neglected financial pitfall that could be undermining your progress: interest.
The average American is carrying $6,000 in credit card debt, and it’s a fair assumption that at least some of them earned points or miles on their purchases. If you’re one of them, it’s vital you read on to learn exactly how it’s erasing the value of the points you worked so hard to earn.
What Is Interest?
We’re hoping you haven’t opened a credit card without knowing what interest is…but just in case, here’s a quick refresher.
Interest is the fee banks or credit card issuers charge customers for borrowing money and not paying the statement balance in full by the payment due date. There are different forms of interest, but this is the general catch-all definition for it.
It’s important to remember that most APRs (Annual Percentage Rate) are annual rates and accrue on a daily basis, not a monthly one.
How Does Interest Impact the Value of Your Points?
Imagine you own a card like the Capital One Venture X Rewards Credit Card. You spend $5,000 on the card within a single billing period, earning 10,000 miles. That seems pretty good. Those miles are worth at least $100 that you can put toward flights or other redemptions.
But you don’t pay off the full balance that month, and the card has an APR of 25%. That means you’ll see around $104 of interest added to your account, effectively negating the value of your miles. Daily calculations mean that number isn’t exact, but it’s a simplified version of it. Compound that figure over three months, and you’re now down over $300 against the $100 you earned in miles.
That’s not good. The bank is happy to give you 2% back on your shopping when it’s charging you 25% to borrow the money.
In short, every cent of interest you accrue is directly countering the value of any rewards you’ve earned.
Even Intro Bonuses Can Become Worthless
You might be thinking, “Sure, but what if I earn a massive welcome bonus? Surely that changes things and outweighs the interest?”
Well, yes and no.
Let’s say you open a new travel credit card offering 100,000 miles after spending $8,000 in the first few months. You’ve done your research, and you reckon those miles are worth around $1,500 when redeemed for flights. Not bad for spending money you were going to spend anyway, right?
But there’s a catch. You can’t actually afford to pay off that $8,000, so you carry the balance while making minimum payments.
At a similar 25% APR, an $8,000 balance would generate roughly $167 in interest in the first month alone. If that balance stayed around the same level for six months, you’d rack up approximately $1,000 in eye-watering interest.
Throw in a $395 annual fee (or even higher), and your $1,500 welcome bonus has delivered just $105 in theoretical value. And that’s before accounting for any taxes and fees on your eventual redemption. Of course, your actual interest costs will depend on how quickly you pay down the balance, but the point remains the same.
A massive welcome bonus is only a win if you can afford to earn it. If you’re borrowing money to hit the spending requirement, you’re potentially handing most of your rewards straight back to the bank.
Don’t Be Disillusioned By Big-Value Redemptions
We often tell you that redeeming an amazing business class flight can sometimes be worth upwards of 5 cents per mile. For example, if a crazy Qsuite across the world costs 100,000 points compared to $10,000 in cash, you’d get a whopping 10 cents per mile. It might feel logical to argue that even if you’ve accrued almost $1,000 in interest, you’re coming out ahead. But for most people, paying $10,000 for a business class ticket isn’t a real possibility, so it’s not a true saving, just a cool redemption. In reality, they may have only been able to spend around $700 on an economy ticket.
And that means the true saving is $700, not $10,000, and with $1,000 in interest accrued, they’re not down $300. But it feels like a win in some weird way.
Practical Advice
Whether you’re interested in points and miles or not, keeping your interest to an absolute minimum should be a financial priority. Use some of these tips to ensure you don’t find yourself hurting your credit score.
Pay your full balance every month
This is the simplest way to avoid interest. Pay your entire balance off each month and prevent any interest from accruing at all. There are obviously times when you may need to use more than you can pay, like in emergency situations. But for regular months, just keep paying everything off, even if it’s a little more than you’d have hoped to spend.
Treat your credit card like a debit card
This goes hand-in-hand with the first tip. Too many people see a $20,000 credit limit and proceed to act like they have that in their bank account. Instead, set a mental limit (or a real one if your card allows) that matches your actual debit card’s balance. That way, you never overspend and don’t find yourself in a hole.
Set up autopay
Hand-in-hand-in-hand with the first and second tips is the simple action of setting up autopay. By setting it to pay the full balance each month, you’re guaranteeing your account stays in good standing and removing the possibility of a slip-up in a busy month.
Prioritize repayment over points
If you’re in some debt, stop chasing points. Your financial stability is far more important than the free flight you want next year. Getting too competitive when you’re not in a sensible place to do so is a recipe for financial ruin. Get your finances in order, then go after the miles.
The Point
There’s nothing wrong with getting excited about credit card rewards. I’m the first person to tell you how brilliant points and miles can be when you use them properly. I’ve saved thousands of dollars on flights and hotels over the years, and I have no intention of stopping.
But none of that would mean much if I were gifting hundreds of dollars back to the banks every month in interest.
You can spend hours researching transfer partners, hunting down award availability, and squeezing every last cent of value out of your points. But if you’re carrying a balance, you’re potentially undoing all that hard work before you’ve even booked a flight.
So, before worrying about which card earns an extra point per dollar at restaurants, focus on the one habit that matters more than anything else: pay your statement balance in full every month.
The best points strategy in the world is useless if the bank is making more money from you than you’re getting back.
