Credit cards are simply financial tools. They won’t make us rich but they can certainly make us poor if we use them incorrectly.
Post the Christmas indulgences maybe it’s time to take a look at how to get these tools to work for us.
I know this doesn’t sound like the a fun read but maybe there is something that can help you manage your credit card use better or better yet maybe you are doing it all correctly and can pat yourself on the back!
The 4 unbreakable rules of using credit cards
Avoid spending more than 30% of your credit limit
I know this is a weird one but it really works.
Firstly, it contributes to building a strong credit profile and as a result good credit score.
Secondly your available credit limit will increase at a much faster rate. A little bit of an anomaly but as you are showing you are a disciplined user and payer you get rewarded.
The key to remember though is the fact that you have a large credit limit doesn’t mean you have to use it. Stick with using the 30% amount if you can comfortably pay it off in full each month. I try to ignore what the total limit is. I know what the 30% amount is and I know I can afford to pay it and so I stick to this as the amount available. This is not because I am a star of managing my credit card, on the contrary it is because I am not and have to play little mind tricks on myself to rein my spending in!
Pay the full balance at the end of each month
A credit card is simply access to a pre-approved loan from the credit card provider. The provider will check your credit score (by the way this check usually results in a small decrease in your credit score) and based on what your score is, will determine the size of the loan available to you and the interest rate you will be charged if you don’t pay your credit card in full.
If you repay the credit card balance in full at the end of each month, no interest is charged and you have basically had access to a free loan from the bank for the month.
The exception to this is if you withdraw cash from your credit card. You will be charged interest from the day that you withdraw the cash and the interest rate charged is generally much higher than the rate applied to your regular credit card balance.
If you only pay the minimum amount (or in a worst case scenario, don’t pay anything at all) you will incur a much higher rate of interest than on any other normal loan. This is as a result of the flexibility of the credit card and ease of obtaining one. The interest will be charge on the unpaid balance of your credit card from the beginning of the month.
If you totally miss a payment on your credit card you will be charged a fee and your interest rate will increase if left unpaid for 60 days.
Don’t spend more than you can afford on your credit card
One of the biggest downsides of using a credit card is the risk of falling into the trap of spending money we don’t have.
Try not to use a credit card if you haven’t built up a comfortable emergency fund. Some financial guru’s see this starting point around £1,000, other studies have shown a reasonable amount to be around £2,500. Start with whatever starting amount you feel comfortable will meet an emergency event.
Ultimately though you do want your emergency fund to be funded to around 3 to 6 months of your basic expenses.
The bottom line is to not spend more on your credit card than you can comfortably pay off at the end of each month.
Only use one credit card
This is very much tied into the point above. It is very tempting to have all that credit available to spend and it can easily get out of hand if we aren’t very vigilant and closely monitor our spending. I know on my credit card I am always unpleasantly surprised at how quickly the balance builds up to my self imposed limit. Those seemingly small purchases add up surprisingly quickly!
Having more than one credit card in use makes this even more complicated to monitor and tempting to use!
By following these simple rules you can comfortably reap all the benefits of using credit cards and avoid the dark side of credit card debt.
The benefits of using a credit card
Safer than cash
A credit card can be cancelled if stolen or you lose your purse. Additionally, most credit card providers will refund you for fraudulent transactions on your card.
Once physical money is stolen or lost it is very unlikely that you will get it back.
Helps to build your credit score
A well-managed credit card can contribute to improving or building a credit score. I recently experienced just how effectively this can work. I wanted to establish a credit score in the US and took out a secured credit card to do so. I was only able to obtain secured credit card as I had absolutely no credit profile and as a result the bank required me to deposit a cash balance equal to the limit. Within six months of using the credit card according to the rules above I have a near perfect score. Yes, this is a mini brag as I am so impressed with it! (Sadly it wasn’t that difficult so probably not that impressive!)
Easy and convenient to use
Credit cards are becoming more acceptable than cash. Not only is cash virtually obsolete when it comes to online shopping, many brick and mortar retailers (especially of the smaller variety) won’t accept it either. I have noticed some of the homeless Big Issue magazine sellers in London are carrying a credit card payment system now!
Section 75 of the Consumer Credit Act 1974 lays out some nice protections for credit card users. You can claim back money paid to defunct holiday or flight providers and amounts paid where goods or services were not supplied, were not up to standard or were misrepresented.
To qualify for protection you have to spend between £100 and £30,000, although where the total item cost more than £100 but only £20 was charged to the credit card the amount can still be reclaimed through the credit card provider.
Additional amounts that could be claimed from the supplier such as postage or other damages as a result of the faulty item can also be claimed from the credit card provider.
Free credit between billing dates
The credit card literally provides free credit between credit card payment dates assuming you pay your credit card in full at each date.
Credit cards can work in most currencies
This is a not such a great benefit as I found out the hard way. The exchange rate and transaction fees the credit card provider applies to non-domestic currency spending is eye-watering. While this is a quasi-benefit make sure to check your credit card terms and conditions before indulging in this convenience and getting wacked with some extreme conversion charges.
Rewards, cash back and complimentary extra’s are an attractive feature of credit cards. Make sure your credit card ticks all the right boxes in terms of the interest rate you are offered and in terms of the rewards you can obtain. I had a credit card that offered airline miles. Unfortunately I was never able to use them on the airline and felt very cheated. I was so much happier when the credit card provider switched to a cash back option and I really felt that I was getting rewarded for using that card.
The complimentary extra’s such as travel insurance and car hire insurance have also come in very handy.
Credit cards are a great for managing our money and provided we use them wisely can be a powerful tool in our wealth building arsenal.