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America’s credit card debt has been on a steady uphill climb for the better part of the last decade. Unfortunately, household debt in America has recently surpassed the record highs of the financial crisis that began in 2008. The number of debtor accounts in the U.S. is led by credit card debt, and the number is rising. The Federal Reserve has recently disclosed that it believes credit card debt in the U.S. is approaching $1 trillion.
No one knows whether this number will continue to rise now that the economy has turned around and people have more expendable cash, but the truth is that many consumers are addicted to their credit cards. They like having the buying power of thousands of dollars readily available, even if, in reality, they can’t really afford to spend that kind of money.
In short, most consumers in America don’t have the discipline to save for purchases but instead buy what they want now with a credit card. Low introductory rates on credit cards and small minimum payments help consumers justify these purchases without considering the long-term monetary commitment they’re making, much less the money they’re spending in interest alone. Consumers are also drawn in by incentives that make it seem like using a credit card is a good idea.
Credit Cards Can Be A Bad Idea
The truth of the matter is that carrying credit cards around in your wallet can be a bad idea, especially if you’re in debt. Why do you think credit card companies spend millions of dollars in advertising each year trying to convince consumers to sign up for their cards? It’s simple: credit cards are a money-making venture for the banks. When used irresponsibly, credit cards are bad for the financial health of the consumer.
Even consumers who pay their cards on time each month are exposing themselves to unnecessary financial risk and thousands of dollars in interest over the life of their balances. With the average household carrying upwards of $15,000 in credit card debt, the payoff time when making minimum payments only is YEARS, and the interest associated with that can turn out to be a huge amount of money on top of the principal balance. Even for those who intend to pay off their balance each month, things can go awry if they miss even one payment. Credit card companies are very unforgiving to those who can’t keep up with their payments and will often levy large penalties and increases to the interest rate to those who miss even one payment. This can get those who can only afford to make the minimum payments in financial trouble in a hurry.
Forget the Incentives
Credit card companies try many different types of incentives to lure consumers to their credit cards. However, think about it for a minute: if these deals were so good for the consumer, why would the bank offer them? The truth is that banks know they can well afford to offer these incentives and still make thousands of dollars in interest off consumers. This is because most consumers never sit down and actually calculate the value of the incentives they receive from credit card companies.
Airline miles are very popular as one of the biggest incentives Americans look for when getting a credit card. Regardless of the amount of interest they pay or the annual fees associated with the card, consumers are convinced that by accumulating miles on their card, they’re beating the system. This is simply not true; the math just doesn’t add up. It’ll take you a significant amount of time to earn enough miles to actually buy a ticket. Meanwhile, the interest you’ve paid and the annual fees levied on the account are generally far more than the value of an airline ticket. The truth of the matter is that, even if you pay off your balance in full every month, it’s almost impossible to beat the system when it comes to airline miles.
Getting cash back is another incentive that seems to draw consumers to the use of credit cards. Credit card companies are very clever in their use of this incentive. Many times, the offer is only good for specific types of purchases, and this may change every month. Many credit cards will require you to go to their website to “activate” the reward categories for the month, and cut you out of the incentive if you fail to do so. The time and effort it takes to keep up with the incentive along with the interest you pay on your purchases makes this a game of diminishing returns. Bottom line: cash back rewards aren’t much a reward at all, and limitations can make them not worth the annual fees and interest you pay on your credit cards each year.
Many consumers continue to use credit card accounts because they feel that the special offers and discounts they receive in the mail each month make paying the interest and the annual fees worthwhile. The truth is that you’ll never come out ahead in this game if you’re already carrying debt. The discounts and coupons you’re receiving are probably causing you to spend money you wouldn’t normally spend, and the interest and fees you pay make this a losing proposition.
Bottom line: you’re never going to beat the system by using credit cards solely to accumulate points, airline miles, or special discounts. The credit card companies are very smart when it comes to marketing these incentives to you but, rest assured, they’re also too smart to ever lose money on these deals. These incentives are designed to encourage you to spend money on their credit cards and pay interest and fees: period!
The Effect of Using Credit Cards on Your Credit Score
Many consumers believe it’s necessary to use credit cards to improve their credit score. In fact, American consumers are obsessed with their credit score. Let’s be perfectly honest about how credit cards affect credit scores. The balances will affect your credit score negatively more often than positively. Even if your payment history is perfect, having a lot of credit card debt is likely to affect your credit score negatively. Anyone considering lending you money will be very interested in how much credit card debt you’re carrying as a gauge of how well you manage your finances. If your debt-to-income ratio gets out of balance, you’ll find it difficult to get important credit, such as a mortgage, even if you’ve paid your credit cards on time every month.
The most important things you’re trying to achieve are financial freedom and building your wealth. You won’t do that by spending money you don’t have. Let’s be clear about a few things: having and using credit cards doesn’t improve your credit score, help you manage your money better, or build your personal wealth. In fact, having credit cards puts you in a catch-22 where it’s impossible to find the right balance. If you have too much credit card debt, lenders will fear you’re a poor money manager and are overextended. Having numerous credit cards with zero balances will make lenders nervous that you have too much available credit, which would allow you to get into trouble with your credit cards very quickly. Either way, your credit cards are hurting your credit status, not helping.
You Don’t Need a Credit Card to Safely Shop Online
Having to use a credit card to safely shop online is a myth that’s been perpetuated by the credit card companies. You don’t want to be one of those people stuck with credit card debt in the US. Notice how many credit card companies tout the strength of their fraud protection as an incentive for you to use their card instead that of a competitor. The truth is that using a credit card online is no safer than using a debit card. The bank on which you draw your funds through a debit card has the same fraud protections as any credit card you can obtain. The notion that someone can easily “clean out your bank account” just isn’t true.
Another advantage of using your debit card is that it’s actually spending your real money. You’re less likely to make a frivolous purchase if you’re dipping into your actual cash to do it. Credit cards, on the other hand, make spending money you don’t have very easy. They offer a “buy now, worry about it later” scenario, which is a dangerous game for anyone prone to following their impulses. Impulse buying is one of the ways consumers can get themselves into trouble; if this describes you, you should be wary of using credit cards to buy merchandise online.
People Who Pay with Cash Spend Less Money
Something about handing over your hard-earned cash makes you pause and consider if what you’re buying is necessary. Using a credit card allows you to push the transaction off into the future; for the moment, it doesn’t affect your bank balance. Those who carry cash spend less money because the purchases have an immediate effect on their net worth, and that can be sobering.
Many successful money managers only carry cash. By determining an amount they can spend in a given period, they force themselves to make wise choices and conserve their cash wherever they can. These are traits and habits of consumers who are focused on building wealth instead of fulfilling their impulses.
What to Do if You’re Already in Trouble with Credit Card Debt
Credit card debt in the US is continually rising and many consumers are in trouble. Being at the mercy of your monthly payments is no way to live, and it can limit your life choices. If you have any credit card debt at all, you should develop a plan to pay it off. While many find it hard to break the cycle, taking some definitive steps can help you begin the process.
Step 1. Stop using your credit cards
If you’re ever going to get your credit card debt situation under control, this is the first thing you’ll need to do. Don’t just take them out of your wallet and stick them in a drawer either; destroy them by cutting them up and rendering them unusable. Of course, it’s important to make sure you’re taking care of the back end process and officially canceling your cards as well. Knowing they’re not available will help you shift your mindset away from credit card dependence and onto a cash basis lifestyle. This is imperative if you’re ever going to get out from under your credit debt load and start building wealth.
Step 2. Develop a credit card payoff plan
Sitting down and working out a plan to pay off your debt will accomplish a number of things. First, it’ll put you solidly back in the driver’s seat when it comes to managing your finances, and secondly, you’ll have a sense of control over your financial life. Instead of being owned by your credit card debt, you can start to own your problem and take the necessary steps to eradicate it. Whether you employ the snowball method to tackle your smallest debt first and snowball your payments into bigger and bigger payments until all your debt is paid off, or you utilize the three-year plan, which is paying the monthly payment necessary to pay your cards off in three years (you can find this amount on your monthly statement), it’s important to set a plan in action immediately.
Step 3. Stick to the plan and set goals for yourself
Your debt problem didn’t happen overnight, and it isn’t going to go away overnight. Chances are strong that it’s going to take some time to get in a better financial position. It’s important that you develop a mindset of wealth building and shift away from the mindset of accumulating stuff.
Set some goals for yourself and celebrate a little when you achieve them. Stay focused and dedicated and you’ll eventually find yourself debt free. The best part is you’ll eventually be able to direct the money you’re paying out in credit card payments to your savings and investment accounts. Then, you’ll truly be on your way to building wealth.
