If you want credit to be a key element that helps rather than hurt your financial picture, you must use credit in a way that promotes financial stability.
So for example, if you take out the plastic to buy a couple of items at the mall because you’ve already spent your clothing budget for the month, that’s not a strategic use of credit. On the other hand, if you choose to put budgeted clothing purchases on a credit card because you will get 5 percent cash back and then pay off the debt within the first billing cycle because the money was already allocated in your budget, then that is smart.
With that in mind, you really should ask yourself two questions before using a credit card:
- What benefit or advantage do you get from putting the purchase on credit instead of paying for it in cash?
- How much more will that purchase cost with the added interest before I finally pay it off?
These two questions can help you decide if your cards are worth using in the first place. They also help you plan what to do with the debt once it has been incurred. Ideally, credit purchases should give you a head start without costing you in the long run.
But to reiterate, be sure to avoid behaviors that tend to put consumers in trouble with credit, such as:
- Put purchases in plastic because you lack cash.
- Using credit because you are spending more than you should at a store.
- Using credit to pay bills or juggle your debts because you can’t make all your payments in a given month.
- Spending on credit when you know you won’t be able to pay off debt quickly before too much interest accrues.
Understand interest rate grace periods
By law, each credit card has an assigned grace period configured in the billing cycle. Basically, if you start a month with a zero balance and then make purchases throughout the month, interest will only apply if you don’t pay the full balance before the end of the grace period. If you pay the balance, no interest will be added and you will not pay anything additional for the purchases you made. As a result, you get the full benefit of any rewards you earn.
On the other hand, if you don’t pay your balance in full before the grace period expires, then interest will apply to that balance. But that’s not the worst: if you start a month with a balance, then the grace period doesn’t apply at all. Therefore, every purchase you make in the next month would have interest applied from day one. Since reward credit cards tend to have high interest rates, the rewards you earn are almost always completely offset by the interest applied.
With that in mind, the only way you really get the full benefit of the rewards you earn is by paying the full balance each month. Otherwise, the rewards are offset by the added interest, and the longer you allow your balances to carry over to the next cycle, the more interest you add.
An example of rewards countered with cash back
Cash back credit cards are pretty straightforward, so for the purposes of this discussion, we will use a cash back credit card to explain the problem you face with rewards offset by added interest.
Let’s say you have a credit card where you earn 5% cash back on food and restaurants. So you use this credit card to make all your grocery purchases in a given month. More or less, he spends about $ 300 a month on food for his family. Therefore, you earn around $ 15 in cash each month.
That’s great, especially if you’re being strategic and paying off that credit card debt in full every month. Either way, you earn cash for the food you would buy, then put the money you’ve allocated into your food budget to pay off this credit card every month. It is the perfect system.
… Until you let a balance roll over from one month to the next.
Let’s say that money starts to decrease because you have some unexpected emergencies. Then you start making minimum payments on the card. Now the interest is applied to your balances. Even with a relatively low rewards APR of 15%, you pay more than $ 3 each month in interest charges. In less than five payments, it fully makes up for the cash back rewards you earned. And that’s only if you stop loading the card! If you make new charges every month, you will pay off those rewards even faster.
Other types of reward credit cards are just as bad
If you think this balancing act only applies to cash back credit cards, think again. Keep in mind that the cash value of each mile you earn when using a travel rewards credit card is only worth about $ 0.10 – $ 0.15. Even if you have one of the newer travel mileage credit cards that offers 2 miles for every $ 1 purchased, it is still only a cash value of $ 0.20- $ 0.30.
Meanwhile, if an annual percentage rate (APR) of 15% is applied, you will see $ 0.15 in additional interest for every $ 1 in the transaction. Of course, it’s a bit more difficult to do the math, but point reward cards are no different when it comes to balancing interest. Simply put, if you are not paying your balances in full at the end of each month, then you are not really getting the benefit that you believe in using a rewards credit card.
Always opt for a low APR on large purchases
With all of the above in mind, part of your credit card strategy must be adapted to ensure that you can pay off your rewards credit cards in full and without fail each month. This maximizes the benefits of using a rewards card.
At the same time, if you know you have a purchase or a series of purchases that you need to make and that you won’t be able to pay in full by the end of the month, don’t bother making that purchase with a rewards card. Instead, choose to use a credit card with the lowest APR you have. This means that less interest is applied each billing cycle when trying to pay off the debt.
Key Questions for Strategic Credit Card Use
By using the information above to develop your credit use strategy, you can begin to use your cards in a strategic way that supports your financial stability rather than putting it at risk. Still, you may have some questions about how to use credit to your best advantage.
Here are five key things to know if you really want to master your credit cards and the debt they create:
- How to pay off credit card debt?
Whether you have credit card debt of $ 1,000 or $ 100,000, it is important to keep up, but to do so, you must have a strategy that guides you on how to pay off credit cards.
- Understanding Your Credit Card Statement
While swiping your cards is certainly not complicated, knowing how to read statements can be. As a result, users get into trouble because they simply don’t understand how their cards work.
- Danger Signs: Too Much Credit Card Debt
When it comes to your peace of mind and well-being, you need to know how to identify the danger signs when you have too much credit card debt, but how do you know when it’s time to seek help?
- Introduction to Unsecured Debt
Almost all unsecured debt is paid off on a revolving payment plan. This means that the amount you owe on your bill each month varies based on the total amount you owe. Credit cards are the most common example of unsecured debt.
- Can my card issuer lower my credit limit?
Lowering the credit limit is a common practice at credit card companies, but there are restrictions before the consumer has to pay fees for it.