Credit Card or Cash: Which To Use?

Credit cards or cash? Credit cards offer convenience and a long list of benefits that cash doesn't provide, but they also represent an ever-present opportunity to fall into a cycle of revolving debt that can last years, decades or even a lifetime.

So how can you identify the best times to plunk down the plastic? Here are a few guidelines.

When the fee isn't the best available deal. If you're thinking of paying your mortgage, health insurance premium or other recurring bill with a credit card in order to rack up reward points, think again. Even if the servicer allows credit card payments (many don't), they'll charge a fee that deflates or even outweighs the value of any reward. The IRS allows credit cards for tax payments, but with a 1.87% to 2.25% processor fee (in addition to the interest rate on the credit card). In contrast, the IRS allows short-term payment extensions for no fee and installment plans for $52 to $120 (depending on the taxpayer's financial situation). Late payments are subject to a penalty (0.5% per month) and interest (the federal short-term rate plus 3%), but the total might be lower than the cost of using the credit card.

When you haven't yet negotiated with a creditor. Whether it's medical bills or some other expense that is unexpectedly large or out of control, before you charge up a credit card and trade one financial problem for another, contact the company's billing department. It might reduce the balance owed or offer a payment plan with terms that are far more advantageous than that of your credit card.

When you are in the process of obtaining a mortgage. Mortgage underwriters don't want to see any changes in your creditworthiness between the time you apply for a loan and the time it closes. If your credit card utilization suddenly goes up, your credit score could take a hit, leaving you unable to qualify for the loan that's on the table. Resist the urge to go shopping for things your new home needs. If you're in the mortgage process, use your credit cards very sparingly if at all.

When you want something you can't afford. It doesn't matter if it's a restaurant meal, a new outfit, the latest smartphone, a vacation you really think you deserve or the wedding you've dreamed of since childhood. Big or small, if you can't afford it, don't buy it. Don't let a credit card trick you into thinking you should have something when it is, in reality, not in your budget.

When you already carry a balance. If you have credit card debt, you can't afford to use your cards. Instead, pay down the balance before you add any new charges to the mix, or you risk getting stuck in a cycle of debt. And make sure you have the best card your credit score can get you. (For more, see "Signs You Need to Look for a Better Credit Card.")

When you want additional warranty or purchase protection. A credit card can be a great way to protect a major purchase. Most card issuers offer purchase protection and an extended warranty for items bought with the card. Visa doubles the manufacturer's warranty, up to one year. MasterCard similarly doubles the warranty, offers 60 days of price protection and even insures the purchase against theft or damage for 90 days. (For both brands, benefits vary by card issuer.)

When you want stronger fraud liability limits. Credit and debit cards all limit cardholder liability in the event of fraud, but credit card protection is stronger. A credit card holder's liability for fraudulent use ranges from $0 (if the loss is reported before any fraudulent charges are made) to $50 (if the loss is reported after unauthorized use occurs). On a debit card, however, liability can be unlimited. It is $0 when the loss is reported before unauthorized charges are made, $50 if the fraud is reported within 2 business days, $500 if the fraud is reported more than 2 but less than 60 days after it occurs, and unlimited when the fraud is not reported until more than 60 days after it occurred.

To take advantage of benefits exclusive to the card. Co-branded credit cards typically offer exclusive benefits specific to the brand. For example, some airline credit cards offer free checked bags to people traveling on tickets purchased with the card. Likewise, some hotel chains offer upgrades or special amenities to guests who pay with a branded card. (For more, see "Should You Get A Gas Credit Card?")

To earn rewards. So many popular credit cards offer rewards programs, it's hard to think of a good reason to carry a credit card that doesn't. The programs are highly competitive: Some offer cash back on every purchase; others pay points. Consumers who qualify can earn hundreds, even thousands of dollars back each year on everyday household spending. (The American Express Blue Cash Preferred card pays 6% cash back on grocery store spending up to $6,000 per year, for a potential rebate of $360. Cardholders earn a smaller percentage back for other categories of spending.)

For security while traveling. People who travel can be more vulnerable to fraud simply by virtue of the unfamiliarity of the local language or surroundings. Lost or stolen cash is gone forever, but a credit card can be shut down and replaced during one phone call.

Avoid using a credit card unwisely. Debt is costly. Don't succumb to the temptation to spend beyond your means simply because a credit card with an available balance beckons from your wallet. Instead, focus on using it as a tool to get added value from your planned spending.

When you do use a credit card, do the math. Figure out if the benefit you seek is worth the cost you'll pay in fees and interest. For more information, see "Credit Card Savings."