How to Use Credit Cards Responsibly

by Krantcents · 50 comments

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Too many people have credit card debt!  As of December, 2011, according to Capital One  there was $801 billion total U.S. revolving debt.  98% is credit card debt!  The total U.S. consumer debt is $2.5 trillion as of December 2011.  The average credit card debt per household with credit card debt is $15,799.  Just about everyone has a credit card and it is time to learn how to use it responsibly!

Credit cards are just like money

Too often, I hear people blame credit cards for their debt as though the devil made them do it!  Credit cards are money just like cash, checking accounts (demand deposits), savings accounts, time deposits, prepaid cards, gift cards, debit cards, money market accounts, online bank accounts and traveler’s checks.  Money is any liquid asset that can be quickly converted to cash or used as cash.  When you do not pay the balance on your credit card bill, it becomes a loan.

Credit cards charge interest on balances 

The credit card company charges interest for the loan and a variety of fees if you are late or do not pay the minimum payment.  Interest rates vary from single digits of 8% to as much as 36% annual percentage rate (APR) based on the cardholder’s credit risk.  There are even some cards that have variable interest rates.  In other words, the interest rate floats based on some base such as the prime rate (index).  The prime rate is the interest rate banks charge their most worthy customers.

Some credit cards charge variable interest rates such as a margin of 8.99-13.99% over the prime rate.  Right now, the prime rate is 3.25%.  Prime rate normally moves with interest rates set by the Federal Reserve commonly called the federal funds rate.  In a low interest environment, you may be better off with a floating rate.  This low interest rate environment is likely to change in the future and you want the lowest fixed interest rate credit card you qualify for, if you have a balance.

How do they calculate the interest?

Most credit companies take their annualized percentage rate (APR) and divide it by 12 to create a decimal multiplier.  For example, the annualized percentage rate is 17.949%, the multiplier would be 1.4958.  Let’s face it, the credit card companies are in the business of making money and they do it very well.  If you do not pay the entire balance, your purchases are subject to the interest charges too!  You will incur interest from the date of the purchase.

Each credit card company applies their policy a little differently, but it suffices to say they will charge you interest on the average daily balance.  The average daily balance is the sum of the daily outstanding balances during that billing cycle divided by the number of days in that cycle.  The credit card company is charging you for all outstanding balances and you rack up interest very quickly at these high rates. Late fees, transaction fees, cash advance fees or return payment fees are added to your balances.

How to avoid  interest

Credit card companies are in the business to make a profit, but you do not need to help them!  The credit card company provides a grace period for you to pay your bill without charging you interest if you pay the bill by the due date.  It generally is 20-25 days from the billing closing date.  Many people use credit cards as a convenience rather than a a line of credit.  Many people use credit cards for rewards of cash rebates, frequent flier miles or hotel or travel points which may be exchanged for flights, hotel stays or cash.

The best way to avoid interest on your credit card is to just spend what you can comfortably pay for at the end of the month.  There are a variety of ways to control your spending.  One way is to establish a budget!  You determine how much you will spend for groceries, clothes, entertainment, dining out and the rest of your expenses.  If I did not mention your particular hot button, feel free to let me know in your comments.  Taking control of your spending is the most important thing you can do to reach your financial goals.

Paying interest for a purchase not only adds to your cost, but it reduces your ability to meet your goals.  So you prepared your budget and you have a goal of 10% savings.  To reach that goal, you cannot spend more than $1,200 a year in clothes.  You could allocate $100 monthly or have $400 for each season.  Your budget amount is your spending limit for that category.  Those are the limits, but you want to pay your entire credit card balance every month.

The key to avoid interest is to tie your purchases to your budget and the cash to pay for it.  One choice is to not spend it until you have the cash.  So you save your money at a rate of $100 per month and you are ready to go shopping.  You need to keep track of your purchases so you do not go over your category (clothes) limit and the total spending limit.  You can keep track based on the receipts and categorize the on a spread sheet or app.  You can check online with your credit card company and have them categorize your purchases.

What else can you do to avoid interest?  You can do a little research and use a list when you go shopping.  You determine how much you spend for a product.  If you usually spend $100 for a pair of shoes, you should not shop for $400 shoes.  It may be on sale for $200, but you just blew your budget by $100.  A list helps provide some discipline to your shopping.  Keeping track of your purchases keeps you more aware of ho w much you spend.  Last, you can return a product if you realize you spent too much.

Final thoughts

For me, the thought of paying interest of 8% to 36% is enough to stop me from buying things I cannot afford.  I would rather invest my money to earn money than to pay interest!  As the statistics point out, too many people spend more than they should using credit cards.  Taking control of your spending is essential to reaching your financial goals.  Some may feel it is not a problem because you can still meet your goals and pay the interest.  Why are you paying such a high interest rate?  If you have good credit, you should be able to get a very low line of credit interest rate between 3-5%.

I still do not recommend spending more than you earn, but there are some instances when you need to replace a appliance or repair the car.  You should have an emergency fund to take care of this expense, but this is just another choice.  If you plan your expenses, you can avoid the interest.  Use credit cards as a convenience not as a source of credit (loan).  Stay disciplined in your purchases by using lists and tracking your purchases.  A credit card is not the problem, but you need to learn how to handle it responsibly.

Photo by:  Andres Rueda

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