Americans love their credit cards. Indeed, an estimated 167 million U.S. adults own at least one credit card, and most own more than one, according to CreditCards.com.
There’s a dark underbelly to that reliance on plastic, and it’s called debt. The average U.S. household with debt carries $15,355 in credit card debt, according to NerdWallet. What’s more, credit card debt costs consumers an average of $2,630 per year in interest, assuming an average interest rate (APR) of 18%.
As convenient as credit cards can be for making purchases without cash changing hands, there’s a temptation to overuse them — to run up mounting balances that are beyond a person’s ability to pay from month to month. And the high interest rates attached to many cards mean those carryover balances tend to inflate fast, turning a minor debt issue into a major debt problem.
There are right times and wrong times to use plastic. Knowing the distinction will go a long way toward helping avoid the credit card debt issues that so many Americans face.
RIGHT: Use a credit card when you can pay off your balance in full, by the statement due date.
WRONG: Use a credit card when you’re carrying an outstanding balance that you can’t pay off. Avoid using plastic if you lack adequate cash flow to pay the monthly balance, or if you’re already carrying a large balance you’re struggling to pay down.
RIGHT: Use a credit card for discretionary purchases, knowing you have money in your budget to pay the card’s monthly balance. By paying off the balance in full, you won’t incur the interest charges that can cause credit card balances to inflate rapidly.
WRONG: Use a credit card to make impulse purchases, without regard to budget and your ability to pay off the card’s monthly balance.
RIGHT: Use a credit card to pay for unexpected expenses for which you expect to be reimbursed, such as medical expenses or home repairs (water damage, hail damage, etc.) — expenses that may be covered by an insurance policy.
WRONG: Use a credit card as an emergency cash reserve. “Everyone should have a liquid emergency fund of three to six months of expenses,” says David J. Haas, a certified financial planner with Cereus Financial Planning in Franklin Lakes, N.J., “so credit cards should never be used for actual emergencies…The worst thing to do is use a credit card as an emergency fund. It can quickly convert an emergency into a true disaster as you start carrying a balance and now your financial flexibility is instantly reduced further.”
RIGHT: Transfer a balance from a high-interest credit card to a lower-interest credit card. “That can be a smart move if you have a plan to pay the lower-interest credit card down,” says Niv Persaud, a certified financial planner with Transition Planning & Guidance in Atlanta, Ga.
WRONG: Repeatedly transfer funds from credit card to credit card, opening new accounts, closing (or forgetting to close) accounts associated with cards you no longer use. Not only can this game of leapfrog get confusing, the frequent opening and closing of credit card accounts can hurt your credit score/rating.
RIGHT: Take advantage of a credit card’s 0% interest offer on purchases. This can be a smart way to purchase a large household item, such as a new appliance. “Definitely consider these offers, as long as you have the discipline to pay off the amount of the purchase in the allowed time period,” says Persaud, noting that many such offers require the balance associated with the offer to be paid within a specific period, such as three or six months.
WRONG: Open and use a credit card to earn miles, points or other perks, even though the card carries a higher interest rate than other cards and you’re not committed to paying off the card balance in full each month. The debt burden this creates can be difficult to escape.
RIGHT: Use a credit card to earn points, miles or other perks, when you’re committed to paying off that card’s balance each month. Those perks can prove valuable for travel and other pursuits, notes Persaud.
RIGHT: Use a credit card for business expenses for which you will be reimbursed. This not only helps track business-related expenses, according to Persaud, but also can be a good way to rack up points, miles or other perks.
WRONG: Use a credit card to fund the launch of a business, without business revenue to pay off the card balance each month. This is a bad idea, she says, because missed payments can harm the business’s and the business owner’s credit score/rating.
RIGHT: Use a credit card to pay certain regular household expenses, such as utility bills, when you’re committed to paying off the card balance in full each month. This makes sense as another way to earn points, miles, etc., says Persaud.
WRONG: Use a credit card to cover regular household expenses, though you’re unable to pay the monthly card balance in full. Here’s another approach that invites debt problems.
This column is provided by the Financial Planning Association® (FPA®) of Northeastern New York, the principal professional organization for Certified Financial PlannerTM (CFP®) professionals. FPA is the community that fosters the value of financial planning and advances the financial planning profession and its members demonstrate and support a professional commitment to education and a client-centered financial planning process. Please credit FPA of Northeastern New York if you use this column in whole or in part.
The Financial Planning Association is the owner of trademark, service mark and collective membership mark rights in: FPA, FPA/Logo and FINANCIAL PLANNING ASSOCIATION. The marks may not be used without written permission from the Financial Planning Association.
Comments are closed.