Credit Cards Aren’t Evil, But…
Within the financial community, credit cards are an extremely hot topic. In the United States alone, American’s regularly carry over $1 trillion (yes, with a “T”) in credit card balances. That’s a really scary number. At the household level, the average balance exceeds $10,000. There seems to be a mix of opinions. Some financial gurus swear by cutting up your credit cards and never looking back. On the other end of the spectrum, you have others who claim that strategically using credit cards can yield additional financial benefits. These benefits include cash back, travel points, and special discounts and offers. No matter which stance people take, nearly every financial expert would agree that credit cards, when not used properly can lead to devastating financial impacts.
Personally, I’m perfectly fine if people choose to use a credit card, but (and this is a very BIG but) only if they are able to have systems and processes in place to make sure their credit card debt doesn’t spiral out of control. If you’re on the fence, here are some guidelines that I recommend following to protect you and your family.
1. Never Carry a Balance
Interest rates are the most dangerous thing about credit cards. The average credit card interest rate falls between 20% and 25%. Let’s assume you have a balance of $10,000. Even if you paid $200 a month, it would take you over 9 years to pay off! Not only that, after interest, that $10,000 worth of goods that you purchased will actually cost you nearly $22,000. Unfortunately, people often fall for the “minimum monthly payment” recommended by the credit card company. This amount is intentionally designed to be high enough that you slowly chip away at your debt but low enough that it will take an eternity. This is why credit card companies make over $100 billion each year just in interest payments.
Interest payments add up quickly and can derail your efforts to reach financial security. For this reason, I recommend avoiding interest all together. Be sure to look at your card’s terms and conditions. Most only accrue interest after the statement cycle has closed. As long as you pay off the balance before this date, you can avoid paying any interest. Most credit cards allow you to set an automatic payment each month to pay entire statement balance. This is helpful so you don’t get hit with a nasty interest bill of several hundred dollars. This can also help you avoid late fees for missing a payment altogether.
If you can’t be disciplined enough to pay off your credit card statement balance every single month, cut up the cards. It’s simply not worth the risk to your financial wellbeing.
2. Credit Cards Are NOT an Emergency Fund
Too many people keep credit cards for emergency situations such as an unexpected car repair or to cover your pet’s $6,000 emergency room visit (I’ve been there, TWICE!) While credit cards can provide quick access to money to keep you afloat, they are a slippery slope to debt. People assume that they will just magically find the cash later to pay off the balance they ran up in a crunch. This rarely ever happens. You should always have an emergency fund for these types of situations. Your emergency fund should be sufficient to cover between 3 to 6 months of your expenses. This amount may vary depending on your specific situation.
Some people like to keep a credit card as an extra line of defense for extreme situations where their emergency fund isn’t enough to cover the unexpected cost. They keep a credit card locked up in their security box and only break it out in a “doomsday” scenario. I’m good with this if that’s your approach, but again, only if you have the discipline to keep it locked away and don’t sneak it out when you have an “emergency” like your iPhone broke and you need a new one.
3. Track Credit Card Charges Like Any Other Expense
Every person should have a budget. Once set, they should meticulously track every expense to make sure they aren’t living beyond their means. This is common sense. You can’t spend more than you make if you want to be financially free. However, one huge mistake I see people make is thinking they can get away with not tracking their credit card charges as a part of their budget. Even if you plan to pay off your credit card balance every single month, you still need to track and subtract your credit card expenses against each of your budget categories.
There are two main reasons why people avoid tracking their credit card charges. First, they assume that the charge is tomorrow’s problem since the bill isn’t technically due today. The problem is that not tracking the charges appropriately, you could unknowingly spend too much in a single category. For example, if you swipe your credit card when you go out to eat, how will you know if you overshot your eating out budget for the month if you don’t track it? Another reason why people track credit card charges differently is for convenience (or laziness) by treating the entire credit card statement as a single expense. Sure, you can save yourself the headache of entering 75 different charges throughout the month, but you can quickly lose sight of which category you’re spending.
Every time you use your credit card, record the transaction just as you would if you paid cash or with your debit card. No exceptions.
4. Understand the Cost of Credit Card Rewards
I’m happiest when I am boarding an airplane ready to head off to a new place. So, naturally, I’m a sucker when it comes to credit card rewards. Rarely do I every pay full price for one of my trips. It’s quite often that I have enough credit card points to cover a some (or all) of my flights or hotels. This is a great perk! However, I learned the hard way when I decided to only use a credit card for all of my daily purchases to maximize how many points I could earn. To make matters worse, I wasn’t following rule #3 above and simply didn’t bother to track my credit card expenses. I assumed that I wasn’t spending more than normal. That was until I got my credit card statement. I was shocked to see that I over a few months I was staring at a credit card balance of over $20,000 (ok, I wasn’t following rule #1 or #2 either).
Sure, I had a shit ton of credit card points when all was said and done, but the interest charges cost significantly more than my reward. I thought I was doing the smart thing in trying to game the system. But, as they say, the house always wins. My advice is to never make a purchase on your credit card just because of the reward you might receive. Spending $1,000 extra dollars just to get $50 worth of points isn’t really the deal you think it is.
Another trap people fall for is “perks” offered by credit card companies for additional services or credits with other companies. For example, our credit card offered 50% off a popular fitness app. What a great deal! The problem was, I bought it because it was on sale, not because I needed it. Not only did I end up paying for something I didn’t use, but I forgot to unsubscribe from the service. By the time I realized over two years later, I had blown over $500 on something I shouldn’t have even purchased in the first place.
When to Cut Up Your Cards
I can’t speak for your level of discipline or ability to handle credit cards responsibly. If you even have the slightest sense that you might not be able to religiously follow the recommendations in this article, put down your device or step away from your computer and cut up your credit cards right now. Seriously! It’s simply not worth the risk. Unfortunately, my discipline with credit cards isn’t because I’m the financial equivalent of Master Yoda, it’s because I had to suffer through many bad decisions with credit cards that cost me tens of thousands of dollars and several years of financial freedom.
I hope this advice is helpful when determining whether or not credit cards make sense for your personal finances. Whatever you do, proceed cautiously. Credit cards don’t have to be this evil entity in your life, but they can quickly become a curse that you wouldn’t wish on your worst enemy.
