If you guessed that the worst thing is abusing them, go to the head of the class. Using credit cards as if they were a free ticket to all those things you can’t really afford would be a sure path to debtor’s prison – if there was still such a thing.
Unfortunately, the facts are that most Americans apparently do abuse their credit cards. Proof of this is the fact that the average American household owes more than $15,000 in credit card debt.
But what’s the second absolutely worst thing you can do with credit cards?
It’s to make just the minimum required payments – even if you know what a bad idea this is.
In fact, it’s such a bad idea that thanks to the Credit Card Act of 2009, credit card companies are required to include on their statements exactly how much interest you’ll have to pay over time when making just the minimum payments.
If you pay close attention to your credit card statements, you’ll also see how much you’d have to pay in order to pay off your debt in three years. Your statement will also show the thousands of dollars you’d save by doing this.
Even though we’ve been warned
Despite the fact that we’ve been warned repeatedly what happens when we pay off our credit card debts too slowly a surprisingly large number of us still do just this. In fact, according to a recent study less than 1% of credit card debtors have changed their payments to hit that three-your goal.
And 29% are still paying just the minimum or slightly more every month.
Cardholders could pay more
One common explanation of why this is the case is that because incomes have grown so slowly after the Great Recession of 2007 that people simply can’t pay more than the required minimum.
But when the credit card companies increased their minimum payments, consumers were able to pay the higher amount most of the time. What this suggests is that they could have paid that much all along. One study done by the National Bureau of Economic Research found that 9% to 20% of card holders could pay a lot more than the minimum amount. They simply chose not to. This was despite the fact that they could see right there in black and white what would happen financially going forward.
A concrete example
Here’s a concrete example of what happens when you make just the minimum payment on a credit card debt.
For the sake of the example we’ll say you owe $5000 on a credit card at 18% interest that requires a minimum monthly payment of $125 (interest + 1% of the balance).
In this case, you would need 273 months to pay off that debt and you’d pay $6923.14 in interest or $1923.14 more than you originally borrowed.
If you’d like to get out from under that cloud of credit card debt a little more quickly there are some strategies that can help.
The first is to arrange to have the minimum payment automatically withdrawn from your bank account on the due date each month. This will at least eliminate those loathsome $25 late fees you’re charged if you miss the credit card company’ s deadline by just a few minutes.
The problem with this is that if you decide to pay more than the minimum you’d have to make a second payment. Unfortunately, inertia stops most of us from doing that. So, instead of setting up a minimum payment to the credit card issuer, set up an automatic payment from your bank to the credit card.
Then instruct your bank to send out the same amount each month and make the amount considerably higher than the minimum payment. Do this and you’ll be forced to do something if you want to reduce your payment to the minimum amount, which you could always do if money is particularly tight in a given month.
Pay your credit cards more than just once a month
If you want to get rid of that credit card balance you don’t have to make one big monthly payment. Instead, you could choose to pay the credit card company as often as you like.
You could use this to your advantage by setting up payments on a more frequent basis that will be easier for you to manage. This could be as frequently as once a week or once every two weeks.
Do you put everything on one of your credit cards in order to earn rewards and then pay off that big bill every month? If you use this approach – of paying on that credit card more frequently – there’s an added benefit. This will improve your credit score because you’ll be using less of your available credit. This is called your credit utilization ratio and makes up 30% of your credit score.
Switch those automatic payments to a debit card
You may be making automatic payments from a credit card each month to cover your utilities, services such as Netflix or Hulu, your health club membership or an insurance premium. A better option is to switch those charges from a credit card to a debit card. That way you’ll be making the payments as they come due instead of using up some of your credit.
If there is some reason why you don’t want to do this, you need to be very careful to make sure that when you pay your bill every month you cover those automatic charges. If not and you’re making just the minimum payment, you’ll fall deeper and deeper into a hole because it’s likely that the minimum payment won’t cover those new charges.
What will then happen is that your total balance will continue to just keep going up. And instead of getting closer to eliminating your credit card debt you’ll get further away.
Consider a debt consolidation loan
If you owe on multiple credit cards one option worth considering is to get a debt consolidation loan and pay them all off. There are important advantages to this. First, you would have only one payment to make a month, which you could cover with an automatic withdrawal, so you’d never again need to worry about missing a payment.
Second, the payment on that debt consolidation loan is almost sure to be less than the total of the payments you’re making on your credit cards.
You’d save money because the interest on a debt consolidation loan would most likely be in the neighborhood of 8% to 12% versus the interest rates you’re paying on those credit cards.
Finally, if you’re mot familiar with unsecured debt consolidation loans, be sure to watch the following video to learn both the pros and cons of these loans.