There are good reasons why credit cards have a bad reputation. If you’re not careful with them you could end up in a world of hurt. The interest rate on credit cards averages 15%, meaning that some have rates as high as 19% or even 21%.
When credit cards are your enemy
Credit cards become your enemy when you make just the minimum monthly payments. Do this and you could end up paying twice as much for everything you buy. Remember that $4 latte you bought with your credit card back in 2012? If you’ve been making just the minimum payments all those years it could actually now be costing you $8.
According to a study done and published on PWC.com, there is an improvement in the way credit card holders are paying their balances. Apparently, more people are striving to pay beyond the minimum requirement. And this is one of the best ways that you can save money on your credit card purchase.
The problem with the minimum payment is compounding interest, which some people have called one of the most powerful forces on earth. You’re never its victim if you pay off your credit cards at the end of every month. But if you don’t, you’ll be paying interest on interest, which is compounding at work. Here’s an example of what happens if you buy something for $100 and it accrues just 10% interest every month. This debt will cost you $10 the first month (00.10 x 100). This will be added to your original $100 debt so you now owe $110 of debt. The next month you will again be charged 10% interest, which comes out to eleven dollars (0.10×110) so that you now owe $121 in debt. While this is a very rudimentary example that does not factor in any minimum payments it does show the power of compounding interest and the effect it can have on your finances.
Here’s an example of compounding interest that does take minimum payments into consideration. Suppose you owed $5,000 at 15% interest and made a minimum payment of $120 a month. Would you like to guess how long it would take you to pay off that $5000? The answer is 266 months or more than 22 years and you would pay $5,729.21 in interest or more that you borrowed.
When credit cards can be your friends
As you have read credit cards can become your enemies when you don’t use them wisely. However, if you do use them sensibly they can be your friends. In fact, you can actually use them to earn by spending. We know this sounds a lot like the old, if it sounds too good to be true, but it is true.
It’s very hard to earn money on your money these days thanks to the fact that the interest rates on savings are so low. We saw one ad recently where an online bank was offering an interest rate on savings of 1.05% on a 12-month CD. If you were to buy a $1000 CD at that 1.05% it would earn you $10.50 at the end of those 12 months. Putting your money into a savings account at a bank would be even worse as they are generally paying 1% or less.
So how could you earn by spending on a credit card?
Today’s super-low interest rates have created a situation where instead of saving money you might actually be able to earn more by spending.
This is actually a two-step process. First, you should, of course spend only what you can afford. If you don’t have a budget you will need to create one and stick to it. According to the 2015 Consumer Financial Literacy Survey published on NFCC.org, only about 40% of all US adults currently have a budget. However, if you can make and stick to a reasonable budget you could put all your purchases on one of the cash back credit cards were you would actually earn the equivalent of 2% on your spending. This is because most of them offer at least 2x cash back with the opportunity to earn 5x on certain purchases. If you were to put $500 on a credit card with 2x cash back you would earn $10 or more than you could earn by putting the same amount of money in a savings account. While you can’t put the really big-ticket items like your mortgage payment on a credit card you could put all of your groceries, your gasoline, clothing, travel and even some of your recurring expenses such as your cell phone or cable bill on one that offers cash back.
What other ways could you use your credit cards wisely. Here’s a short video with 10 helpful tips.
The bottom line of credit cards is that they are your frenemies. If you treat them with respect and use them wisely they can be your friends. You can earn money by using them and they are certainly a more convenient way to pay for things then carrying a big wad of cash or even writing checks. But they can be your worst enemies if you don’t use them wisely by running up big balances you can’t pay off immediately, failing to make your payments on time or making only their minimum payments. Americans are carrying on the average more than $6000 in credit card debt. Don’t be one of those people. Getting buried under a load of debt can literally cause you physical as well as financial problems.