Put the Safety on Your Bad Debt: How to Avoid Shooting Yourself in the Foot with Credit Cards
Credit whizzes and personal finance gurus are always talking about good debt vs. bad debt. Good debt, the argument goes, is debt that finances an investment – a home, an education, a business loan. It’s the debt that gives back (provided you don’t default). Bad debt, so they say, is debt that takes and takes and gives nothing back but finance charges. However, the most prominent bugbear of bad debt is something that nearly everyone (excluding hardcore no debt mavericks) carries in their wallet: the credit card.
The problem with labeling credit cards “bad debt” is that they are, for most of us, a necessity. Some might even go as far as calling them a necessary evil – but that isn’t completely accurate. True, that credit card in your pocket is a loaded gun – one that could easily be used to shoot yourself in the foot, financially. But like a gun, it is only dangerous if misused. If handled properly, a gun is no more dangerous than the various tools you might keep in your workshop or garage. In the same way, a credit card can be used wisely and safely. Perhaps it’s still bad debt at the end of the day, but through moderation and mindful spending, you can lessen the inherent dangers of revolving credit. Here are some tips on how to put the safety on your bad debt:
Keep Your Balance Low
The best interest rate you can pay on your credit card debt is zero. How can you do that? Simple: Don’t carry a balance in the first place. In an ideal world, your credit card exists only to allow you to make purchases without carrying cash, earn rewards, build your credit rating and make purchases online. This is the relationship you’ll have with your credit card if you can afford to pay off the full balance on your credit card statement every month. This, of course, is not a simple task. But there are ways you can make it easier:
- Don’t speculate on your income. Calculate how much money you will have each month and budget out your purchases. Don’t make purchases and promise yourself that you’ll work overtime, cut another expense or magically happen some extra coin. Don’t spend your paycheck or income tax refund before you have it. Only buy when you have the cash in hand.
- Don’t get in debt in the first place. This is easier said than done, but because debt has a tendency to snowball, thanks to interest accruement, late fees and other charges, it’s much easier to tame a small or nonexistence balance than one that has already become a problem.
- Get a credit card with online statements. Don’t wait until the end of the month to find out how much you owe. Keep tabs on all your purchases by checking once a week. This will allow you to curb your spending ahead of time, rather than having an unpleasant surprise at the end of the month (or worse, a maxed out card).
If you simply aren’t in a position to carry no balance on your credit card, all hope is not lost. The following tips are for those who carry a balance:
Consolidate
If you have multiple credit cards, you’ll find handling the steadily mounting interest much more manageable if you consolidate your debt. You can do this by moving your high interest debt to your lower interest cards, taking out a debt consolidation loan or by transferring your balance to a new card. Keeping tabs on your payments is much simpler when you only have one bill to pay, and the lower interest rate may save you hundreds of dollars in the long run. But beware: many debt consolidation options come with hidden fees, balance transfer fees and bait-and-switch introductory rates. Read the fine print before signing up.
Negotiate
Your credit card terms are not set in stone. For those of us who have had their rates jacked up or their credit limits decapitated, this should come as no surprise. But if you’ve been a good customer, you can get your terms adjusted in your favor as well. In fact, even if you are over your head in debt, you can likely work out an agreement with your lenders that make everyone happy (or happier, at least). Your creditors would rather be paid a little bit than have you go bankrupt and thus pay nothing.
The first step to negotiation is to evaluate your situation. Why do you deserve or need different terms? Has your credit rating improved? Have you cleared up an erroneous item on your credit history? Or is it simply impossible to make your payments and you need to make a compromise with your creditor? Build a case as to why better terms are beneficial to both you and the creditor, take a quick lesson on how to talk to creditors and call them up. If that doesn’t get you any traction, then it’s time to move on…
Shop Around
The credit card industry is highly competitive – and with issuers constantly trying to one-up and undersell each other, you benefit. Of course, you should avoid jumping from one card to another (that looks bad on your credit history), but if you’ve had the same credit card for years and the benefits keep getting cut and the fees and interest rates keep climbing, it may be time to end the relationship. Look for a card with a lower interest rate and better perks for your current situation, which may have changed since you got your previous card.
Pay More than the Minimum
The minimum payment is set by credit card companies for their benefit, not yours. Oftentimes, when you pay the bare minimum on your credit card statement you are only maintaining your level of debt. Instead of treading water and racking up more profits for the issuer in interest fees, pay as much as you can afford to each month. The more you put towards your debt, the less you’ll pay in the long run.
Don’t Save Your Pennies
If Benjamin Franklin was alive today, he might revise his oft-quoted adage to: “A penny paid towards your high interest debt is a penny earned.” Before you squirrel away cash into your savings account, a money market account or invest it in stock, pay down your high interest debt. Why? It’s simple. If you are racking up 12.24% in interest on your credit card debt and accruing only 1% interest from your money market or CD, then you are still down on your net returns by 11.24%. And you’d have to find a damn good investment opportunity to make more than a 12% return.
True, it’s important to have some liquid assets in case of emergency. But trying to make a return on investments or savings rates before paying off your high interest debt is about as fruitful as bailing out your boat before plugging the hole that’s letting all the water rush in.
Don’t Use Cash Advance or Convenience Checks
No matter who you are or what your level of debt is, it’s never a good idea to use your credit card’s cash advance or “convenience check” features. These perks were invented by credit card companies solely to extract money from you. A cash advance is when you pop your credit card into an ATM and withdraw money. This debt has no grace period, has a higher interest rate, and oftentimes can’t be paid off until the rest of your balance is zeroed out. The result: you pay far more in the long run for that $50 or $60 you pulled out of the ATM at the last minute.
The same goes for the bulk of the convenient offers provided by your credit card issuer. If it seems like something that won’t really make your life easier, then avoid it. If it seems difficult to understand or has lots of inscrutable fine print, skip it. Play things safe by using your credit card only to make normal purchases online or at the register.
Don’t Live Beyond Your Means
The overall lesson for keeping your credit cards from sabotaging your finances is to simply spend within your means. A credit card is not meant to be exercised to its full potential. Credit card companies put more power into those little pieces of plastic than you can responsibly wield. Determining how much you can afford, what you should and shouldn’t’ buy and when to make your payments is your responsibility. Think of the speedometer in your car – chances are it goes up to 140 MPH. But no one in their right mind would ever dream of going that fast – speed limits or not. Likewise, it’s never a good idea to rev your spending up to a rate that is too fast for you to stay in control. The realities of the road are the same as those in personal finance: it’s the reckless driver that’s dangerous, not the vehicle.
Photo by another_finn
Related posts:
[...] Your Card presents Put the Safety on Your Bad Debt: How to Avoid Shooting Yourself in the Foot with Credit Cards posted at Master Your [...]