Credit cards can be great. Their convenience and ease of use, combined with the ability to extend your budget, makes them almost a necessity in today’s world. However, credit cards are not all good; in fact, they actually lead many people into crippling debt, bankruptcy, and financial ruin. While many of my previous posts have discussed why credit is important, this post will exclusively provide caution to people just beginning their use of credit cards.
Many of us, thanks to student loans, are already in debt. Credit cards can make this situation even worse. Credit card debt is scary, as it can build up quickly, easily, and seemingly effortlessly. How can this happen? Well, it’s all about how you pay off your balance. Obviously if you simply don’t pay, your debt will climb, due to increasing annual percentage rates, late fees, and more.
But it can grow even when you think you are being responsible with your payments. The most common scenario is when you only make the minimum payment on your balance. This is usually around 2-3 percent of your balance at the end of the month.
As you can see from the table above, making just the minimum payment, even when always on time, will make it incredibly difficult to pay off your debt in a timely manner. And this is just a scenario where the balance is $1,000 and is not growing due to continued card use, which would likely happen in real life.
Another way people fall into circles of debt is when they use one credit card to pay off the balance on another. A person in this situation would, in essence, be rotating the debt from one card to another, never actually reducing their balance, but actually increasing it due to the interest that accumulates. People in this situation may even end up opening new credit cards in order to pay off other cards, further compounding the problem.
Like most things in life, credit cards have both an upside and a downside. The good news is that these upsides and downsides are not out of your control. The downs happen when you are irresponsible in your use of credit, and the ups happen when you are responsible. Avoid the downside of credit cards by reducing your use, keeping your balance down by making more than the minimum payment on your balance, and not using one card to pay off another. Practicing smart money habits will go a long way toward allowing you to maximize the benefits of credit and avoiding the negatives.
For more information on building credit and choosing credit cards, as well as a variety of other topics, check out AIER’s How to Use Credit Wisely Digest. Dedicated to helping people understand credit, the How to Use Credit Wisely Digest is a great resource for anyone interested in getting their financial lives on track. Best of all, it’s free!