Everyone appreciates the importance of using credit cards responsibly; the issue comes down to tactics.
How do you use your credit cards to your advantage without also over using them to the point where they become a problem?
Let’s face it, credit cards are extremely user friendly!
Everything about them tempts you to use them even more. From generous (and often rising) credit limits, to zero-interest introductory rates, to cash rebates and rewards, to the completely self-directed nature of the credit arrangement pull us into what is probably the most cozy relationship with any kind of debt we’ll ever have.
But credit cards are loans—as in debts that are required to be paid back. If we ever lose sight of that we’re at risk of becoming credit card junkies or bankruptcy candidates.
How do we stay on the safe side of credit cards?
1. Use a Spending Hierarchy
One of the fundamental reasons people get deep in debt is through overuse of credit cards.
Paying with credit cards becomes the automatic method of payment for everything from a $4 cup of coffee at Starbucks to a $200 grocery order to a $4,000 room full of furniture.
Ironically, the larger the purchase the easier it is to track.
It’s the relentless flood of relatively small but everyday purchases that can lead to big problems.
It’s not hard to add over $100 to your credit card balance in a single day of paying for nothing more than incidentals. $15 for an online purchase, $15 for lunch, $40 for gas and a $30 trip to the grocery store to “pick up a few things” is all it takes. Multiply that by 30 days and it’s not hard to see why so many people experience monthly credit card bill shock.
You can prevent this by working out a spending hierarchy, based on the amount of the purchase.
You could, for example, decide that any purchase for less than $25 will be paid in cash, any from $25 to $100 will be paid by debit card, then restrict your credit card to transactions above $100.
Fewer transactions with your credit card will mean a substantially lower bill each month.
2. Set a Maximum Balance That’s Well Below What the Card Issuer Allows
If you aren’t disciplined about using your credit cards it’s easier than you think to max them out.
Once you do that, the credit line becomes a complete liability—a large loan balance that needs to be paid down with no additional credit available to be used for future purchases. It becomes a pure drain on your cash flow.
Whatever the maximum balance the card issuer allows, set your own maximum that’s much lower–preferably a balance you’re sure you can pay off in full each month. If you go above it, put your card away and go to all cash until you can pay the line off.
Here’s another reason to stay well below your credit card limit: one of the most important metrics in determining your credit score is credit utilization—that’s the ratio of credit outstanding to maximum credit available on a credit card. The higher that ratio, the greater the negative impact on your credit score will be.
3. Never Use Your Credit Cards as an Extension of Your Paycheck
The cost of living is always rising so it’s easy to see why people might use all kinds of ways to cope with this.
Using credit cards is, unfortunately, the quickest and easiest way to pay for what your paycheck no longer covers.
That’s how credit cards start to become an extension of your paycheck.
Credit cards are not an income source, but a way of borrowing against future income. That means your future cost of living will be even higher because you’ll have to pay the added cost of paying back the money you’re borrowing to live today.
There are only two ways to deal with the rising cost of living effectively—either earn more money, or lower your expenses.
Credit cards do neither and when you start using them in this way you’re only creating a much bigger problem later.
4. Don’t Think of Your Credit Cards as an Emergency Fund
Do you know people who don’t have an emergency fund—and maybe think of the unused portion of their credit balances as filling that role?
I know some people who think like this.
There are at least two problems with this idea; the first is the definition of “emergency”.
For some that word means a medical catastrophe or a job loss—a true emergency by any definition. But to others an emergency can be any time they’re short money in their monthly budget!
It’s easy to see where that can lead.
The second problem is that it can mask a lack of savings.
If you don’t have at least an emergency fund saved, you’ll be completely dependent on credit cards any time you need some extra money. Savings are the best way to avoid the kind of imagined emergencies that can max out your credit lines. If you have no savings of any kind, it’s just a matter of time until that day will arrive.
Savings are savings, and credit is debt—never mistake one for the other.
5. Pay Your Card Balance Off In Full Each Month
This is the most widely used advice on credit cards, which is why I held it for last.
We’ve all heard this advice before, but it’s one of those pieces of wisdom that’s easier to recite than it is to put into practice.
But if you follow the other four methods above, paying off the balance each month should be so much easier.