Welcome to Frugal Fridays where we share money saving tips, discuss living frugally and generally talk about personal finance issues. As I was writing last week's diary on teaching children about finance I got to thinking once again about credit cards and how they are used or how they use us, as the case may be. I'm in sort of a rush this week, so here are just some of my scattered thoughts that have been pinging around my head. As usual, please use the comments to add your own ideas.
Disclaimer: I am not a financial professional. I'm just a consumer who tries to be educated. Take anything I say with a grain of salt.
The last time I raised this topic, several people responded that in their opinion, credit cards should be avoided at all cost in all circumstances. I, obviously, have a different opinion. I think they can be really useful tools in your financial arsenal and, used wisely, they can be quite beneficial to consumers. However, these benefits are predicated on following one simple rule:
Rule Number 1: Pay your entire credit card balance off in full each and every month.
If you don't live by this rule then you are going to end up in one of two situations:
- You will pay interest charges on every purchase you charge. Think of this like a surcharge that applies to every charge you make. This surcharge could be an extra 10%, 20% or more depending on how long you take to pay off your balance, and how high your interest rate is.
- You may be able to avoid most interest charges by refinancing your debt to a new card every few months, but this takes a fair amount of time and effort on your part to make sure that you roll the debt to a new card before the teaser rate expires on your current card.
In short, if you can't follow Rule #1, it is going to cost you either time or money (or both).
Other Rules For Wise Credit Card Use
There are a few other rules you should follow to avoid the troublesome pitfalls of credit cards, and to take advantage of their benefits, but none is anywhere near as important as Rule #1:
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Never use a credit card for cash advances: Most cards charge a fee for cash advances and they charge interest from the moment you withdraw the advance (no grace period like there usually is for purchases). Even if you pay your bill off immediately, the effective interest rate you pay will be very high.
- Always pay your bill on time: If you miss a payment deadline, the interest charges will start accumulating immediately. If this happens to you, try calling customer service and seeing if the late fees and finance charges can be reversed. If you don't get an answer you like, try calling back and speaking to a different agent. They often have quite a bit of leeway and you just need to find one who is sympathetic to your situation.
- Pick a card with a long grace period: This is the period of time between when you make the purchase and the bill is due. The longer the period, the longer you are using their money as an interest free loan.
- Pick a card with a good rewards program: I've found that cash is the best reward they can give, but you may be able to use travel or other rewards better.
- Use one-time use numbers for internet purchases: Most credit card companies have a method for generating such numbers from their website. If the number is compromised, you don't need to close your entire account.
Turning Over a New Leaf
OK, so I have convinced you that carrying credit card debt is a situation to be avoided, but even over the internet I can hear you ask, "once you have such debt, what's the best way to get out of it?" If you are carrying high interest debt, you need to make it your number one priority to reduce that debt. That means you need to make a budget, stick to it, and divert every spare dollar you have to paying down that debt as soon as possible. The only exception to this diversion that I would make is that you should continue to fund your 401K plan up to the limit that is matched by your employer. While some people might argue that you should build up your savings while trying to pay down your debt, this doesn't make financial sense as long as the interest rate you are getting on your savings is less than the interest rate your are paying on your loan. Look at your credit card statement and somewhere down at the bottom it will say what the Annual Percentage Rate (APR) is that your are paying for accumulated purchases and for cash advances. If that number is higher than your savings account interest rate, then you are losing money by putting it in savings.
Refinance Your Debt (Borrowing From Peter to Pay Paul)
If you are paying over 10% interest on your current credit card debt, you may be able to refinance this to a lower rate with another lender. You could take advantage of an introductory rate on a new credit card and transfer your balance. If you transfer your balance to another card, do not use that card for any new purchases. Keep your new charges separate from any old debt you are trying to pay down. Alternatively, you may be able to get a home equity loan or some other secured loan from your bank or credit union. You could also look to friends or family for a loan. It would be better to pay your friends 8% interest than the credit card company 20%, but there are obviously lots of potential problems when you add a financial dimension to an existing relationship. Circle Lending is a third party that will set up and manage this loan for you. The fees they charge may be well worth the relationship you preserve. If you do refinance your debt, you need to be very careful that you don't start building up new debt on your new credit cards.
Forbearance to Reduce the Balance (Ask and You May Receive)
If you are in a serious credit hole, you may be able to negotiate some sort of balance reduction with your current credit card companies. It can't hurt to ask and you may be surprised at what they are willing to offer. If the first agent turns you down, ask to speak to someone else (or just call back). Keep in mind that any reduction in balance will be treated as income in the year you receive it and you will owe taxes on that amount.
Further Resources
If you want to read even more, here are some good resources I've found:
- Consumer Reports has an extensive article in the October issue on credit cards including a survey of the best and worst cards as reported by their readers. (Subscription Required)
- Business Week has an in depth five part series looking at credit cards and college students.
- The Red Tape Chronicles at msnbc.com has a clear explanation of the difference between debit and credit cards and why using debit cards is a worse choice than credit cards for most people.
Frugal Tip of the Week: According to this list and this list, October is the month when back-to-school clothes, fishing supplies, cars, toys, china and crystal all go on sale.