Let's Talk Credit Cards
Let’s talk Credit Cards.
You get the advertisements weekly – both electronically and physically. This credit card and that credit card promising excellent rewards and you pre-qualify! Every time you fly with one of the major airlines, they ask you if you would be interested in earning miles or points for this flight and every purchase – just get their credit card!
We are inundated with credit card options. Some give cash back, some come with travel credits, some reward you for shopping in certain places, and they all want your business.
Maybe you heard Dave Ramsey’s opinion on them (credit cards = bad, always) and you just want a second opinion.
Here’s how they work: A credit company agrees to pay for things you buy with the agreement that you will pay the company back. If you pay them back quickly, they will not charge you any interest on the money you borrowed.
Wait – you might have be thinking that you did not borrow money, after all it’s your credit, right?
No. The company decides how much borrowing power they will allow you to have based on things like your credit score and your income. Borrowing power? Yes, because that’s what it is, you are borrowing money from them every time you swipe that card.
If you do not pay them back quickly, they will start to charge you interest on the amount you owe them. Most of them charge high interest rates (over 10% usually, and in many cases over 20%) on any carried balance. That minimum payment they recommend for you? It’s enough to cover any interest you owe them for the month and still make your balance decrease, though not by a lot.
Oh, and if you make a late payment? You better believe that’s being reported and will affect your credit score (we’ll talk more about that in a future post), which could affect your ability to get a home (purchased or rented) or a car.
Reward Programs:
Many companies will offer incentives to make people want to use them, like cash back or travel rewards. Truth be told, these rewards are only worth it if you pay off the credit card. 2% cash back sounds good, but not if you are paying 24% interest. That cash back only gets paid on what you spent at the retailer, not what you spend on interest.
Ever wonder how these companies can offer such great rewards just for spending your own money? Because they are making money hand over fist on the average American. Read on to find out how.
How Credit Card Companies Make Money:
Here’s the thing, credit card companies do not really want you to pay them back in full every month. Why? Because if you pay them back in full every month, they cannot charge you interest and therefore they are not making (as much) money on you.
Credit Card companies make money when you pay them back slowly. For instance, let’s say you owe them $100 from last month. You make a payment, but only pay $50. Starting next statement cycle (usually monthly), they will start charging you interest on the $50 you still owe them. If that interest rate is 26%, then at the end of the month they’ll charge you $1.08 in interest.
Now, $1 may not seem like a lot, but imagine you owe $500 instead of $50. Now they get to charge you $10.84 for that month.
In 2019, the Experian Consumer Report stated that the average American has over $6,000 in credit card debt (unpaid balance). Combine that with the fact that these companies charge an average of 19.2% interest (According to MindGeek) and you find that Credit Card companies make an average of $1,152 per person per year. The US Census Bureau estimates that 200 million Americans have credit cards. Of course, these are just averages, but that means these companies are making billions of dollars in interest on unpaid balances every year.
If everyone paid their card off at the end of the month? The credit companies would still make money because they charge the stores you shop at a fee every time a card is used. That’s why some stores will offer you a discount if you pay cash (or charge you 3% more if you use a credit card). Those retailers are getting charged by the credit card companies every time someone uses one to pay! For a long time, many stores did not accept American Express cards because they had such high fees per use.
Here's another tidbit – interest accrues daily. It only gets charged if you do not pay off the statement balance, but every day you carry balance is a day they are adding up interest. What does this mean to you? Even if you cannot pay off your entire balance this month, the earlier in the month you make a payment, the less interest you get charged.
Let’s look at the math. If the interest rate on your credit card is 24% (also known as APR or annual percentage rate), then that breaks down to approximately 0.07% per day (assuming a 365 day year). So, for every day that you owe $100, you are charged $0.07. Over the course of 30 days (a full month) you’ll owe $1.97 for every $100 you owe. If you pay $100 halfway through the month (so that you’re only charged interest for 15 days), you’ll only be charged $0.07x15days=$1.05.
These are small numbers, so it doesn’t seem like you save much money by making earlier payments. However, if you owe thousands of dollars instead of just $100, these savings multiply.
Responsible Credit Card Use:
So, here’s the truth: Credit Cards are what you make them. Misused, they can drive you and your family into deep consumer debt that affects your ability to buy a home or a car, that can eat up your entire income, and can destroy you financially. Used well, they are convenient to use and offer some benefits to the consumer. Credit Cards are a tool, but most of us have not been taught how to use them responsibly.
How you approach credit cards will vary based on your own financial discipline. If you find that you reach for the card to make purchases that you don’t need or you can’t afford, it may be time to cut those suckers up, pay them off and stick to the Dave Ramsey approved envelope and cash method.
There have been studies done, and spending money “hurts” less and is easier to do when you use a card versus paying with cash. So, if you struggle to reign in your spending, it may be best to leave the cards at home.
If you are disciplined and find you can tell yourself “no” or are good at tracking your spending and reigning yourself in, when necessary, credit cards aren’t all bad.
Either way: Pay them off. You do not want to be charged interest on your purchases, especially at the 20% and up range that many cards charge.
Already have debt and cannot pay them off? Pay more than the minimum payment (if you can) and get those paid down as soon as you can. While you’re doing that, avoid putting any other charges on those cards.
Moving Forward:
· Only spend what you can afford to pay off. If you planned to spend that money, you can put it on your credit card. Avoid impulse buys. Actively and intentionally control how you spend your money, especially when using your credit card.
· Pay them off every month.
· Make your payments on time. Set up Auto-Pay. Even if the AutoPay is set to just the minimum, this automates your payments so that you won’t get hit with late payment charges in case you lose track of time and the month gets away from you. This will also protect your credit score (we’ll discuss that later).
· Look into a card that has rewards that make sense for you. If you don’t fly much, a travel reward card probably does not make sense for you.
· Avoid having too many credit cards. The more accounts you have, the more you have to keep up with, and the more likely it is that you’ll lose track of a due date and either forget to make a payment or forget to pay off the balance. Plus, if you forget you have a card you put yourself at a higher risk of not noticing if your account gets stolen or wrongfully charged.
· Review your statements and keep your receipts. Companies and people make mistakes. There’s a chance a retailer could have double charged a purchase (it has happened), or that the tip you left at the restaurant was added incorrectly. Double check the statement to make sure those charges are correct. If they aren’t, reach out to the company to get them corrected (this is easier when you have receipts to prove what you are claiming).
Emergencies:
Life happens. Things break. You might want or need to spend extra money on the credit card this month, even though you know you cannot afford to pay it off in full because there was an emergency. It happens. Be careful with this loophole though and be very honest about what constitutes an emergency. You should be going to your emergency fund to pay for real emergencies.
If you have yet to fully fund your emergency fund and need to rely on your credit card? Don’t get down on yourself or beat yourself up for slipping up. Do be diligent about being honest with yourself about 1) Is this really an emergency, 2) Could you have prevented this unexpected cost with a little more planning, and 3) How can you budget for this type of thing in the future.
Unable to Make Payments
If you find yourself in financial hardship and are struggling to make the minimum payments, call the credit card company. Ask if they can temporarily reduce your interest rate or suspend your payment and interest charges for a while. They can never say yes if you never ask, and sometimes they’ll cut you a break just for asking.
If you have any other thoughts on Credit cards or questions I haven’t answered - drop them in the comments!
I’m glad you’re here.
Cheers!
