People have a strange relationship with credit cards. Some people use their credit cards as if it’s loaded with their own money. Some people look at credit cards as a gift straight from the devil designed to poison us. The fact is that credit cards are neither of those things – they are good, but they can be used poorly. Let me explain that statement.
Credit cards are a means to borrow money. With a credit card, you can buy things that you normally wouldn’t be able to if you don’t have the enough money to pay for it right away. This can be advantageous when making large charges, such as paying for flights for a vacation. A lot of chequing accounts have limits of how many transactions you can make in a single month, so being able to put small purchases on a credit card is convenient.
The main issue with credit cards isn’t with the cards themselves, but rather with how people use them. A lot of people treat credit cards as if it’s their own money and will rack up large balances because there’s still room to spend on the card. Remember, it’s not your money, you’re borrowing the money from the credit card company to make your payment. Using all of the room up to your credit limit on your credit card to buy things you wouldn’t normally have the money to get is a sure way to rack up debt that you can’t pay off. The danger of a credit card is that you can get yourself into a lot of trouble really quickly. Remember my last post on saving money while you’re out? Or the post about ways to stick to your budget? I said that using cash will make you spend less. Credit cards make you feel like you have more buying power than you really have.
Racking up a large balance that you can’t pay off right away is REALLY dangerous. Credit cards are notorious for overcharging on interest rates. If you carry a balance from month-to-month, you get charged interest for the WHOLE BALANCE of what the bill was, not just what you didn’t pay off. This would be bad enough itself, but credit card interest rates can range anywhere from 20%-25% annually!!! Imagine you carried a balance of $1,000 over from one month to the next. You’re going to pay a lot more money than you need to – not to mention the ding on your credit score every time you don’t pay off your bill.
Credit score is basically the score that credit companies give you on your ability to pay off your debt. If you make your payments on time, your credit score will be higher, which means you’ll be cleared for larger loans or lines of credit in the future. That is VERY useful when you’re buying a house or apartment. If your credit score is not high enough, you may not get a good sized mortgage or you may not get a low interest rate on that mortgage. It’s a long topic to cover, so I’ll go over that in a separate post in the future.
Meeting your minimum payments is not enough, you need to pay everything off in full, or you’re going to end up paying more for your purchases than what they’re worth. How does the interest work?
Simplified, this is how it is calculated: $1,000 balance x 20% Annual interest = $200. $200/12 months = $16.67 of interest you’d pay per month. This doesn’t sound like a lot, but when you consider that this is just for one month of not paying of your bill, it’s a little scary. When the next month comes, not only are you paying the interest on the previous bill, but I’m sure there are a whole bunch of new purchases tacked onto that bill as well that you’ll have to pay off. If you can’t pay that off, then you’ll start accumulating larger and larger interest payments onto your credit card bill. It’s a cycle of accumulating debt.
Credit.com says that the average American pays about $279,002 of interest over their lifetime. That’s $279,002 of payments that could have been completely avoided! Let’s not forget the conversion rate to Canadian dollars either. If the average Canadian is in roughly the same shape, that would equal $357,122.56 of interest payments over your life. If you make $50,000 a year for a salary, that’s a little over 7 years of working for payments that NEVER HAD TO HAPPEN. It’s so easy to put yourself into serious debt and spend way more money than you ever need to just by tapping your credit card for purchases and not paying the bank back when the bill is due.
Don’t get me wrong, I use my credit card all the time. Small purchases, big purchases – I don’t discriminate. I know how much money I can spend monthly based on my current pay, so I rarely exceed my own personal budget rarely. The key is to know your limits of what you can afford to spend within your budget.
Let’s say that you use your credit card responsibly and only spend what you would’ve been able to spend in cash. You would be able to pay off your bill every month and would not be paying any interest at all. You would be boosting your credit score by showing the banks and credit card companies that you can make timely payments in full to your loans. At the same time, you’d also be gaining points on your card and depending on how your loyalty system might work, you might be able to get enough points for something small, but it’s a small reward. You could take more vacations with all of the money that you’re saving or invest it to get an even better return. You could go out and do more things and have more disposable income.
It’s not hard to see why so many lives are ruined by debt and it’s not hard to see how easy it is to fall into the traps of credit cards. When used correctly, they can be great tools to use, but when used incorrectly, they could cause lots of stress and financial problems in your life.
There are so many intricacies with credit cards and debt that I couldn’t possibly get them all into one post. Next week, I’ll be covering different ways that you can handle your credit card debt and different tips to help you use them effectively.
If there’s anything you want to add or ask about, please feel free to comment below!
Thanks for reading, eh!