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Personal Finance
The Proper Use Of Credit Cards

David Berky -- Credits cards are a convenience, not a crutch.

The upside of credit cards

Credit cards are a great way to make purchases and record your spending to the penny. They also provide a way to postpone payment on items, thereby earning you more interest on your money.

For example, if you have a money market account that gives you 5% annual interest and you spend $1,000 a month through your credit card, you can keep that $1,000 in your money market account for an additional month. At the end of a year, you will have earned an additional $51.16 for doing nothing

Now $51 may not be much but it's free!

Also, you can use your credit card statements to keep track of exactly how much you are spending and where your money goes. With some credit cards you can use personal finance software to download your credit card transactions from the Internet right to your home computer.

Credit cards may actually save you money. Some people avoid making purchases if they do not have cash. Cash seems to "burn a hole" in our pockets; it just disappears. It is so easy to spend and it is right there. But a credit card takes more effort and you know that you have to pay the bill later that month.

Your credit card may also offer a rewards program where you get cash back, frequent flyer miles, or discounts on services and merchandise.

Credit cards are convenient. Some purchases, especially those on the Internet, will only accept credit card payment. Plus, you don't have to continually go to the bank or ATM to get cash.

A credit card also provides a measure of safety. You don't have to carry large amounts of cash for large purchases. Even if your card or credit card number is stolen, you are not responsible for the thief's use of your card. [Editor's note: check the credit card company's policy. Many will not hold you accountable for charges above a certain amount if your card is lost or stolen and you notify them of the theft.]

The downside of credit cards

But credit cards can also be a crutch. Too many people see their credit limit not as the maximum amount of debt they can go into, but as an account full of money that they can spend.

Average household consumer credit balances have now topped $7,000. The monthly interest charge for a credit card charging 18% interest is over $100. That translates to over $1,200 a year just in interest alone.

And this interest is not like home mortgage interest that you can deduct from your taxes. You are paying an additional 15-36% on top of the $1,200 for taxes on the interest you are charged. That brings your interest charge total up to $1,400-1,600 each year. Even more if your balance or interest rate is higher.

What is silly is that many people who are paying 18% interest rates on credit are also investing in a stock market that only averages 11%. Or worse, keeping money in money market, savings accounts, or CDs that only pay .5-3%.

Want an investment that returns over 20%? Invest in paying down your debts. In the above example you can save over 20% with taxes factored in.

The consequences

Many people have developed the habit of using their credit cards to buy what they want now and paying for it later. They then make only the minimum payments required. Often the minimum payment is set so that you only pay the monthly finance charge (interest) or just a small amount above it.

This will keep people paying that 18% rate for years. A $1,000 purchase can end up costing $1,500 when paid off after five years. Ironically many of these same people will wait months for a sale so that the item's price goes down 10-20%, then make a purchase on their credit card and end up giving the savings to the credit card company instead.

Sometimes the credit card can lead a person into living a lifestyle that is beyond his/her means. If a person gets in the habit of dining out two to three times a week, and these meals are paid for by credit card, the card balance increases quickly. Often the additional expense was not planned or budgeted. People can even end up spending more each month than they actually earn.

This can continue as long as the credit card balance is below the limit and the person makes regular monthly payments. But as soon as the credit limit is reached, many credit companies will increase the credit limit and give the person more room to get into debt. I have personally seen a credit card limit expanded by $10,000 within three months.

This cycle can continue until these people are required to make a minimum payment that is more than they can afford. Now not only do they have to cut back on the lifestyle they have grown accustomed to over the years, but they also have to either increase their income or cut out things they enjoyed before they enhanced their lifestyle with their credit card.

Even worse, what happens if the person is suddenly out of work or has to take a pay cut or lower paying job? That's right, the credit card bills keep coming. And many people rely on the remainder of their credit limit to supplement their income until they are working again or can find a better paying job.

We have seen this cycle in America increase average credit card balances each year and eat up the equity in many people's homes. Home equity loans are used as credit cards to live a lifestyle that is beyond these people's means. Or to purchase toys they really can't afford to buy, let alone keep and use. Or the home equity money is used to "pay off high interest credit card debt," as the ads suggest. But then people continue the habit of living off their credit cards and get right back into debt again.

Old fashioned self-discipline

So what is the answer to America's growing debt problem? Abolish credit cards? Nationally imposed credit limits?

How about a little old fashioned self-discipline? I know it's not in style anymore, but it is still the best policy.

Bottom line: pay off your credit card balance each month. Don't buy something now and expect the big end of year bonus to pay off your credit card. Even if you do get it, you will probably spend it on something else.

Don't fall into the habit of living off your credit cards. If you have $1,000 of disposable income to spend each month, whether through a credit card or in cash, only spend the $1,000. Don't try to make up for extra expense this month by assuming you can catch up on your credit card payment next month. It won't happen.

If you have developed bad credit habits, cut up your credit cards, or only keep one for emergencies and resolve to pay off the balance each month. Then create a plan to get yourself out of debt and stick to it.

You can relieve stress, avoid family conflicts, and sleep better at night knowing that there are no credit card wolves howling at your door.

David Berky is president of Simple Joe, Inc., which sells the Simple Joe's Debt Eraser PC software. Debt Eraser can help anyone get out of debt quickly and inexpensively by creating a Rapid Debt Reduction Plan, located at

© 2004 Simple Joe, Inc.

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