Financial health: Use credit cards responsibly and gain a financial tool
Sunday, November 20, 2016
Credit cards often are compared to power tools. Used responsibly, they can be a very effective financial tools, but when used improperly, they have the potential to be dangerous and destructive.
According to a 2015 study by NerdWallet, the average American household has $15,675 of credit card debt, and the average household is paying a total of $6,658 in interest per year (including credit cards, mortgages, auto loans and other consumer debt), which is 9 percent of the average household income ($75,591) being spent on interest alone.
How can you avoid the credit card pitfalls and mountain of debt that plague the “average American,” yet take advantage of the true benefits of using a credit card? How can you use a credit card as an effective financial tool? The following five strategies can help you boost your credit rating, budget more effectively, and avoid the stress and overwhelming credit card debt with which so many Americans struggle.
1. Pay off your balance every month.
Charge only what you can afford, and pay your bill in full every month. This is challenging, but it is the only way to avoid getting into credit card debt, and the only way to avoid paying interest on your purchases.
2. Never skip a bill, and never pay your bills late.
Pay your bill every month, even if the minimum payment is all that you can afford. Missing a payment could result in late fees and higher interest rates and a negative impact on your credit score. Most issuers charge a hefty late payment fee. Also, 35 percent of your credit score is based on your payment history, so missed or late payments can wreak havoc on your credit rating.
3. Use your credit card as a budgeting tool. Using a credit card to pay for day-to-day expenses is a smart idea if you live within your means and pay off your bill every month. By making all of your purchases with a credit card, you can see exactly how much you have spent each month. Log into your online credit card account frequently (at least once per week) to help you track your expenses and stay aware of how much you have spent so far during the billing cycle. Most online credit card sites offer a spending analysis tool. This allows you to see a breakdown of how much you are spending with your card in different categories (restaurants, groceries, travel, clothing, etc.). This can provide some helpful insights into where you are sticking to your budget, and where you might need to cut back.
4. Stay well below your total credit limit.
In order to keep your credit score healthy, keep your balance well below your credit limit. The credit utilization ratio is the percentage of the total available credit that you are using. Credit issuers like to see a credit utilization ratio of approximately 35 percent or less. For example, if you have a credit limit of $5,000, a 35 percent credit utilization ratio would mean that you have a balance of $1,750 or less. Set up balance alerts with your credit card company so that you receive a text and/or email whenever your total spending hits a certain threshold that you have set. You don’t want a situation where you are close to maxing out your credit limit. This could hurt your credit score.
5. Use credit cards with reward program. If you use a credit card for the majority of your daily purchases, find a card that offers rewards such as cash-back, hotel loyalty points, or frequent flyer miles.
You can earn some great financial perks just by using your credit card for regular expenses such as groceries or gas. Make sure that your credit card purchases are for things that you would spend money on anyway, though, not luxury or frivolous expenditures.
Using a credit card responsibly requires a lot of self-discipline, but the resulting financial benefits and peace-of-mind make it well worth the effort. Following the tips above will help you to make your credit card a very effective financial tool.
Anne Fisher teaches in the Department of Finance in the College of Business at East Carolina University.