Most people have at least one credit card. And that’s OK. In fact, many credit cards offer financial benefits, such as points that can be redeemed for deals on travel costs and other perks. However, it’s when credit cards get out-of-hand that issues arise. Many Americans are in serious credit card debt.
Credit cards shouldn’t be considered a fountain of travel or money machines. Using credit cards should be considered part of your overall cash management strategies. There are ways to use them wisely, for financial benefit. And there are also ways to use them poorly, making moves that can disadvantage you financially. The key is knowing how to use them.
At PAX Financial Group, we help clients get control of their finances. And over the years, we’ve realized that debt problems often stem from the fact that many people simply don’t know how to use credit cards. So, we’ve compiled some simple tips.
1. Decide on Their Purpose in Your Financial Life
The first step is to decide what you want to use credit cards for. Credit cards can play multiple positive roles in your financial life. They can be used to save money on purchases, to reduce existing monthly payments, to make large purchases and to build credit (and thus credit ratings).
If you’re looking to save money, a cash-back card, for example, will reward you a certain percentage of cash (usually through accumulated points) from your purchases, once you reach a certain threshold. Effectively, this can decrease the price of the goods and services you receive cash back on. Other credit cards give you reward points for travel, which can effectively reduce your costs for travel.
Perhaps you currently have debt on high-interest-rate credit cards and want to roll that debt over to a lower-interest-rate credit card. This can save you on interest rate charges overall, and may reduce the monthly payments on your credit card debt as well.
Another strategy is to use a credit card for a large purchase, and pay the debt off in a month so you don’t incur interest rate charges and fees. This can work well, but you need to be sure you can pay it off.
Finally, credit cards can be used to build a credit history and thus credit ratings. It’s prudent to have the best credit rating you can, because people with higher credit ratings often receive better terms from financial institutions on products, such as mortgages.
If you have no credit history or a poor credit history, using a credit card prudently (paying bills on time and not charging up to the limit or going over) can, over time, help give you a history (if you don’t have one) or build a better one (if it needs strengthening).
2. Shop Around to Find the Best Terms
Once you’ve decided what you need a credit card for, it’s time to shop around. People should get into the habit of finding the terms credit cards offer before applying. Not all credit cards are created equal – they don’t all have the same terms. The interest rates you’ll be charged, annual fees and other charges vary. You, of course, want the lowest you can find.
Interest rates on credit cards are currently high – more than 17 percent. The interest rates are usually discussed as an Annual Percentage Rate (APR). Before choosing a card, see if it offers low or 0 percent introductory rates, which can amount to savings. Be sure to note when the introductory rate ends.
Some credit cards charge an annual fee every year; others don’t. It’s to your financial advantage to find one that doesn’t, all other factors being equal.
Many credit cards will charge fees for various services, such as transferring a balance or obtaining a cash advance. A large percentage will charge late fees if the monthly bill is late. Be sure to find out what the fees are.
3. Use Credit Cards Wisely
Once you have a credit card, use it wisely. Most crucially, don’t think of it as a magic tree of money. The money you charge is not free; you will pay for it. Remember, over time, you will likely pay 17 percent or more on your credit card debt. In other words, if you charge $3,000 on a particular card, the interest in one year will be a minimum of $510. That’s more than $42 per month just to service the debt, not for the purchases alone.
With this in mind, use your credit card strategically. When you purchase something on it, you should be in line for some sort of benefit related to its initial financial purpose for you. Will you receive cash back points? Travel points? The use of a big-ticket item you’ll pay off shortly? A boost to your credit history? All fine purposes.
However, if you’re using a credit card simply because you don’t have the cash to afford what you’re purchasing, it may be time to rethink your cash flow. It’s a good idea to work with a financial advisor to create a workable budget.
Despite how you may feel about money, when you ask yourself how to build your dream life, the answer shouldn’t just be credit cards!
Second, make sure you pay the credit card bills on time, always. Doing so will build your credit rating. Not doing so will negatively hit your credit rating and expose you to late fees and penalties.
Third, keep on top of what you’re putting on the credit card every month. Pay your credit card bill completely every month, if you can. It can boost your credit score to do so. But more importantly, perhaps, it’s a way to avoid suddenly having a mountain of miscellaneous charges that, once interest rates are factored in, will cost you much more than purchasing via cash would have.
4. Reduce Existing Balances
If you currently have existing credit card debt, devise a strategic plan to reduce the balance. The negative effect of monthly credit card debt payments on your disposable income (including the high interest rates) can sap the money you have available for goals like retirement savings or vacations.
There are two primary methods to reduce credit card balances. Both are useful because they can give people with a great deal of debt momentum in paying off their debt, making monthly progress visible.
In the first, called the snowball method, you put your credit cards in order of balance amount. Devote as much money as feasible toward paying down the smallest balance. Once it’s paid off, you move on to the next smallest balance.
In the second, called the avalanche method, you place them in order of APR, highest first. You pay down the highest-APR card first. After it is paid down, you move on to the next highest APR.
To devise an optimal plan for your credit cards and other cash management strategies, consult a financial advisor you can trust.
This material is provided by PAX Financial Group, LLC. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. The information herein has been derived from sources believed to be accurate. Please note: Investing involves risk, and past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All market indices discussed are unmanaged and are not illustrative of any particular investment. Indices do not incur management fees, costs and expenses, and cannot be invested into directly. All economic and performance data is historical and not indicative of future results.