Enter my newly minted credit card. Okay, fine. It was a card on my mom’s account. But I had strict orders not to charge anything other than gas and I was permitted to use the card for other charges with prior permission. Every month, when the bill came, my mom and I would sit down, review the charges, and true-up what I owed her to cover my expenses on the card. This is one of the most valuable things she could have taught me. If you read my post on credit scores, you would know that credit history is one of the factors that goes into your score. My parents started me young and helped me build my credit history in a positive way.
A credit card is a short-term loan.
The Economic Principle:
Credit cards offer consumers the ability to charge items without having to immediately pay cash. We’ll get into why this is good and bad below.
The thing about credit cards is that handled responsibly, they can give you a great many benefits. These can include things like cash back, miles, points to stores, etc. Basically, you’re getting these benefits for free when you spend money you were going to spend anyhow. Here’s the rub: it’s only a benefit if you pay your card off every month. If you’re carrying a balance, those benefits are not free.
Credit cards make money off of you in a few different ways:
- Purchases: The credit card company charges vendors (the places or people you pay) a fee on every charge
- Late Fees: Make sure you pay at least your minimum payment on time every month. These fees are the equivalent to lighting money on fire. You are in full control of your payment being made on time, so just make sure you do, okay?
- Interest Charges: This is the scourge of anyone with a balance on their cards. Usually, the rates are very high, and they charge compounding interest – some daily, some monthly. Compounding interest means that you get charged interest on your interest. This makes credit card balances the equivalent of very expensive loans
- Annual Fee: Some cards that offer great benefits charge an annual fee for the privilege of using the credit card. If you use the card a lot and the benefits surpass the fee, this may be a worthwhile expense. That said, if you’re carrying quite a few cards and they all have annual fees, maybe focus your spending on one or two accounts and forego the rest.
As we discussed in last week’s blog post, while carrying a balance on your cards will impact your credit score, consistently paying at least the minimum payment every month gives you a good payment history, which is the largest percentage of what makes up your credit score.
So, what can you do if you’re carrying a credit card balance? I’ve seen a few recommendations for working with professional companies to help you reduce your interest rates or consolidate your loans. If you want to try going at it alone first, a popular method is called the Debt Snowball.
The Debt Snowball:
This method consists of paying off your smallest debts first, so you rack up wins along the way in your debt payment journey. Simply put, make a list of all of your outstanding loans in order by amount. Pay the minimum amount on all of your debts every month and any extra money should go to the smallest debt. As you get rid of the smaller debts, you can put more money towards the larger payments until you’re down to one large debt and you are focusing all of your payments on that single debt.
With all that said, I’m going to end this blog post sounding like a PSA: charge responsibly!