Three Reasons Why Credit Card Debt is Dangerous
Credit cards are tempting, almost seductive. They give you freedom to say yes to opportunities, travel, and education. With credit cards, you can do things now, without having to get a loan, or save up for later when you can actually afford to pay cash. Students who no longer qualify for student loan funding may be able to get through a semester by putting daily expenses on a credit card. If you have available credit, you can cover emergency car repairs and avoid being late on bills, if money is short.
While there is value in having the freedom a credit card offers, many people fall into a trap and use credit cards more than they should, well beyond their ability to repay. When spending falls less in the “need” category and more in the “want,” you can get into real trouble. As humans, we have “present bias” which puts more weight on the gratification of instant rewards than those in the future. For example, you may want to buy a house, but it’s easy to disregard that goal in favor of a last-minute weekend getaway to San Francisco. Below I will discuss the reasons why credit card debt is dangerous.
REASON #1: Treating Yourself Is NOT Helping Yourself
Some people justify credit card spending by calling it therapy, and believe they should treat themselves to something nice after a hard week. The instant gratification with the insert of a chip or swipe of a card, can come at a hefty price, or worse, put you in a downward financial spiral. There are many, many reasons people take on credit card debt:
Grief and loss
Anxiety / Stress Relief
Entitlement (“I deserve to treat myself”)
Impulse spending (“You only live once!”).
Credit card companies don’t help your cause, they want you to spend. They purposely give you low minimum payments, that will take years and years to pay off, while making it easy to justify additional spending. Your $1,000 weekend trip to San Francisco with 17% interest rate and monthly payments of $50, will take you two full years to pay off. If you have less than perfect credit, your interest rate may be higher. The average maximum APR is 24.99%.
REASON #2: Credit Card Debt Can Spiral Out of Control
If you find yourself being only able to make the minimum payment on your credit card, it’s time to make some changes. While there are various expert strategies of how to eliminate credit card debt, the most important first step is cutting up your credit cards, and stopping all spending. If you make automatic payments on your card, transfer these to your debit card. Note that you should not close your credit card accounts, as this can hurt your FICO score.
If you cannot make your minimum credit card payment, do not just skip it. It will not go away. Your creditor will charge a late fee and report it to credit bureaus if it is more than 30 days late. Additionally, you may be assessed a “penalty APR” after two late payments, or per the terms of your cardholder agreement. If you know you cannot make a minimum payment, and cannot think outside the box to come up with some additional income to make the payment, you need to contact your credit card company to make arrangements. They may or may not be sympathetic, but if it is a one-time occurrence, they may extend your due date.
REASON #3: Credit Card Debt Can Hurt Your Credit
Aside from late payments hurting your credit, keeping high balances impacts your utilization, or debt-to-credit ratio. One of the reasons you should not close out credit accounts is closing accounts increases your utilization ratio. The less you utilize your credit limit, the higher your FICO score will be. For an example scenario, let’s say you have two credit cards, one with a $1,500 limit, and one with a $1,000 limit. The card with a $1,000 limit has a zero balance, and the other has a $1250 balance. Your utilization ration is 50% — your $1,250 balance divided by your $2,500 credit limit. If you close out the $1,000 limit, your utilization will go up to 83.33%, as you will be using $1,250 of your $1,500 credit limit. This increase in your utilization will hurt your credit, even though you owe the same amount. You should keep your debt-to-credit ratio, or your utilization, as low as possible, ideally below 30%.
Practicing Self Control in the Pay-Down Process
Be prepared for a slew of offers from your credit card company as you pay down credit card debt, and as your credit card company notices you are not using your card as much, or at all. Credit card companies make money when you carry balances, so they will want to incentivize you. They may try to lure you with “convenience checks” so you can make big purchases or transfer balances in the short term. Or they may raise your credit limit, giving you more access to funds in hopes that you will be tempted to spend again. If your credit cards are cut up, or at least safely tucked away in a drawer at home, and not in your wallet, it will be easier to shred these promotional offers and not give in to more spending.
Making Positive Changes for a Better Future!
If you have credit card debt, you’re not alone. More than 40% of U.S. households carry credit card debt. Dave Ramsey’s Financial Peace University reports that U.S. households spend more than $412 billion in credit card purchases annually, with less than half (45%) of cardholders making only the minimum payment. When you feel tempted to pull out your credit card, remember that the more money you have in the bank, the more freedom you have, now, and in the future. Change your spending habits, and change your life!
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