Proper use of Credit Cards
by David Berky
Credits cards are a convenience,
not a crutch.
Credit cards are a great way to make purchases and record
to the penny your spending. They also provide a way
to postpone payment on items and thereby earn more interest
on your money.
For example, if you have a money market account that
gives you 5% annual interest and you spend $1000 a month
through your credit card, you can keep that $1000 in
your money market account for an additional month. At
the end of a year you would have earned an additional
$51.16 for doing nothing.
Now $51 may not be much but it's free!
Also you can use your credit card statements to keep
track of exactly how much you are spending and where
your money goes. With some credit cards you can use
personal finance software to download your credit card
transactions from the Internet right to your home computer.
Credit cards may actually save you money. Some people
avoid making purchases if they do not have cash. Cash
seems to "burn a hole" in our pockets, it just disappears.
It is so easy to spend and it is right there. But a
credit card takes more effort and you know that you
have to pay the bill later that month.
Your credit card may also offer a rewards program where
you get cash back, frequent flyer miles or discounts
on services and merchandise.
Credit cards are convenient. Some purchases, especially
those on the Internet, will only accept credit card
payment. Also you don't have to continually go to the
bank or ATM to get cash.
A credit card also provides a measure of safety. You
don't have to carry large amounts of cash for large
purchases. Even if your card or credit card number is
stolen, you are not responsible for the thief's use
of your card.
But credit cards can also be a crutch. Too many people
see their credit limit not as the maximum amount of
debt they can go into, but as an account full of money
that they can spend.
Average household consumer credit balances have now
topped $7000. The monthly interest charge for a credit
card charging 18% interest is over $100. More than $1200
a year just in interest.
And this interest is not like home mortgage interest
that you can deduct from your taxes. You are paying
an additional 15-36% on top of the $1200 for taxes on
the interest you are charged. That brings your interest
charge total up to $1400-1600 each year. Even more if
your balance or interest rate is higher.
What is silly is that many people who are paying 18%
interest rates on credit are also investing in a stock
market that only averages 11%. Or worse, keeping money
in money market, savings accounts or CDs that only pay
Want an investment that returns over 20%? Invest in
paying down your debts. In the above example you can
save over 20% with taxes factored in.
Many people have developed the habit of using their
credit cards to buy what they want now and paying for
it later. They then make only the minimum payments required.
Often the minimum payment is set so that you only pay
the monthly finance charge (interest) or just a small
amount above it.
This will keep people paying that 18% rate for years.
A $1000 purchase can end up costing $1500 when paid
off after 5 years. Ironically many of these same people
will wait months for a sale so that the item's price
goes down 10-20% and then make a purchase on their credit
card and end up giving the savings to the credit card
Sometimes the credit card can lead a person into living
a lifestyle that is beyond their means. If a person
gets in the habit of dining out two to three times a
week and these meals are paid for by credit card, the
card balance increases quickly. Often the additional
expense was not planned or budgeted. People can even
end up spending more each month than the actually earn.
This can continue as long as the credit card balance
is below the limit and the person makes their regular
monthly payments. But as soon as the credit limit is
reached, many credit companies will increase the credit
limit and give the person more room to get into debt.
I have personally seen a credit card limit expanded
by $10,000 within three months.
This cycle can continue until the person is required
to make a minimum payment that is more than they can
afford. Now not only do they have to cut back on the
lifestyle they have grown accustomed to over the years,
but they also have to either increase their income or
cut out things they enjoyed before increasing their
lifestyle with their credit card.
Also what happens if the person is suddenly out of work
or has to take a pay cut or lower paying job. That's
right, the credit card bills keep coming. And many people
rely on the remainder of their credit limit to supplement
their income until they are working again or can find
a better paying job.
We have seen this cycle in America increase average
credit card balances each year and eat up the equity
in many people's homes. Home equity loans are used as
credit cards to live a lifestyle that is beyond people's
means. Or to purchase toys they really can't afford
to buy let alone keep and use.
Or the home equity money is used to "pay off high interest
credit card debt" as the ads suggest. But then people
continue the habit of living off their credit cards
and get right back into debt again.
So what is the answer to America's growing debt problem?
Abolish credit cards? Nationally imposed credit limits?
How about a little old fashioned self-discipline? I
know it's not in style anymore but it is still the best
Bottom line: pay off your credit card balance each month.
Don't buy something now and expect the big end of year
bonus to pay off your credit card. Even if you do get
it, you will probably spend it on something else.
Don't fall into the habit of living off your credit
cards. If you have $1000 of disposable income to spend
each month, whether through a credit card or in cash,
only spend the $1000. Don't try to make up for extra
expense this month by assuming you can catch up on your
credit card payment next month. It won't happen.
If you have developed bad credit habits, cut up your
credit cards, or only keep one for emergencies and resolve
to pay off the balance each month. Then create a plan
to get yourself out of debt and stick to it.
You can relieve stress, avoid family conflicts and sleep
better at night knowing that there are no credit card
wolves howling at your door.
© Simple Joe, Inc.
David Berky is president of Simple Joe, Inc. which sells
the Simple Joe's Debt Eraser PC software. Debt Eraser
can help anyone get out of debt quickly and inexpensively
by creating a Rapid Debt Reduction Plan.
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