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Using Credit Wisely

Credit cards are a great convenience. They allow us to purchase goods online, keep us from having to carry large sums of cash, and enable us to pay for emergency items that we may not have the cash for, such as an unexpected car problem or home repair.

But this same convenience can also make it far too easy to spend beyond our means, and before we know it, we've racked up thousands of dollars of debt that may take us years to pay off. Fortunately, there are some guidelines you can follow to avoid falling into this trap:

Don't use credit cards for everyday items.

Sometimes we don't "feel" those small purchases of $5 or $10 when we pay by credit card, but they can add up very quickly. For example, spending $7.00 on lunch five days a week works out to $150 a month or $1820 a year! While you probably could have managed to shell out $7 in cash for each of those sandwiches, you might find it harder to come up with $150 for the credit card bill at the end of the month. And that's assuming the only thing you charged all month was lunch, which probably wasn't the case. Once you tack on a few evenings at the movies, that new outfit, your sister's birthday present, drinks with your friends, concert tickets, and the oil change that your car needed, you're in for a real case of sticker shock. You are incurring more credit card charges than you're able to pay off each month and the cycle of debt begins.

To keep your credit card balance manageable, use cash or debit cards whenever possible, especially for small purchases; create a detailed monthly budget that includes a certain amount for savings; and refrain from charging non-essential items to your credit card if you can't afford to pay for them in full within two months.

Pay your balance in full if you can.

If you are going to use credit cards, then paying the balance in full each month is the best assurance against running up debt. You can also end up paying less by not incurring interest charges, but take note... Some credit card companies impose finance charges from the day you make a purchase or the day the charge is posted to your account. Others extend a "free period" or "grace period" whereby you can avoid paying finance charges if you pay your balance in full before the due date. Contact your credit card issuer and ask them about their policy.

Pay more than the minimum.

Many people are tempted to pay only the minimum balance on their credit card since it frees up cash for other bills or purchases. But since minimum payments are usually between 1 and 4 percent of the credit card balance, you end up paying a lot of money toward interest and not a lot towards the principal. As a result, it can literally take years, not to mention hundreds or thousands of dollars in interest, to pay off your balance. Let's look at what would happen if you paid the minimum payment every month on a $2000 balance. We'll assume, for simplicity's sake, that you don't make any other charges on the card:

Paying the Minimum

 

Starting credit card balance:

$2,000.00

Annual Interest Rate:

18%

How is minimum payment calculated:

2.5%

Time it would take to pay off debt:

18.5 years

Total interest paid:

$2,615.00

As you can see, it would take 18 ½ years to pay off that $2000 balane...and the interest you would pay - $2,615 - would actually exceed the original $2000 balance! But here's the good news... If you pay $60 every month, even after the minimum amount starts to decrease, you can pay your balance off in just under 4 years and pay only $793 in total interest. So, if you can pay your balance in full each month, by all means do so. But if you can't, always pay more than the minimum.

To calculate the true cost of paying the minimum on your credit card, go to http://www.bankrate.com/brm/calc/minpayment.asp

To calculate what it would take to pay off your credit card balance, go to http://www.bankrate.com/brm/calc/creditcardpay.asp

Always pay your credit card bill on time to avoid being charged a late fee.

And remember that the due date is the date by which your payment must be received; not the date that you mail your payment. In addition to late fees, failure to pay your bill on time can trigger a permanent interest increase. And if you habitually pay late, it can negatively affect your credit rating, which could make it difficult for you to get credit, loans or competitive interest rates in the future.

Avoid cash advances.

A cash advance refers both to using your credit card at a bank or ATM machine to withdraw cash and to using the checks that your credit card company may have provided to you. In some cases balance transfers are also treated like cash advances, so ask your credit card issuer about this. Cash advances can end up costing you because they are almost always subject to higher interest rates than regular purchases. There also may be a cash advance fee on top of the interest. Payments may be applied to purchases before cash advances, so it can take awhile to pay of the cash advance, especially since that higher interest rate on the cash advance balance keeps compounding. So before taking out this high-interest loan, consider other options.

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