FINANCIAL FRESHMAN #020
TL;DR → Once you understand how your credit card works, building the right habits is key to using it effectively. Treat your card as a tool to manage cash flow rather than a loan, set up automatic payments and alerts to stay on track, and avoid cash advances to minimize extra costs. With these habits, you’ll be well on your way to mastering credit without paying unnecessary interest.
Introduction
In our last two posts, we’ve summarized credit card interest accrual, and outlined the method that your card likely uses to apply interest to your balance. Both of these articles highlight the idea that credit card interest can get out of hand quickly, and make it imperative to understand the mechanics of your specific credit card.
However, understanding how your credit card works won’t be enough. Just like with all things personal finance, it’s your behavior that will govern your success. While you’re still in college or just beginning your career, establishing positive credit card habits will help you set a foundation for a positive financial future. In this article, we’ve outlined 5 habits for you to consider.
Habit #1: Ignore Your MMP
The first habit to adopt is to…pay more than your minimum monthly payment, and to routinely pay your credit cards off in full if you can. I feel compelled to get that out of the way early since it’s so obvious, but I’d also like to discuss the mindset shifts that can make this habit come more organically.
Letting this habit into your financial life means that managing your credit cards is almost clerical. Swiping your credit card becomes “I’m spending money now” in lieu of “I can pay this off later.” When this is your reality, you can quite literally ignore your minimum monthly payment amount. What you pay towards your credit card matches what you spent on that card.
If you’re more motivated by numbers, consider this simulation below of paying off a $1,000 balance on a credit card that accrues 20% interest and has a minimum monthly payment of $25.
Does it surprise you that only adding $5 per month to your monthly payment knocks 1 year and 5 months off the payoff time, and saves $190 in interest? It surprised us too.
Individuals that successfully take advantage of credit cards will never have to do this math, since they never swipe for things they couldn’t pay cash for in the first place.
Habit #2: Budget Accordingly
If you’ve graduated from habit #1, that means that you already think about credit cards as tools to manage monthly cash flow, rather than loans. The next habit to outsmart your credit cards involves updating your budgeting practices to ensure your credit card balances never get out of hand. Let me show you what I mean, starting with the wrong way to go about this.
Take this budget cross-section as an example, where we see allotted spending for 6 categories: Rent, Groceries, Water, Electric, Netflix, and a Credit Card. Can you pinpoint what’s wrong with a budget that looks like this?
Budgets like these plan for the credit card minimum monthly payment, but do not take into account credit card spending. If your budget looks like this, you have a budget, but you’re not budgeting.
Budgeting for effective credit card use means that, when you swipe a credit card at the grocery store, that amount hits your “Spent” column under your “Grocery” category, in the same manner that it would if you paid with your debit card. The fact that you used a credit card is irrelevant; you spent the money.
Make sure that your budgeting practices set you up for success when it comes to your credit card habits. Subscribe to be first in line for the Financial Freshman budgeting template, which will do all of this work for you.
Habit #3: Put it on Autopay
Graduating from college and entering the workforce is a perfect time to begin establishing positive credit history, if you haven’t already. A whopping 35% of your FICO score comes from the payment history towards your debts. Especially when you may have little credit history in the first place, one of the worst things you could do is miss a payment entirely.
Most (if not all?) credit card issuers offer an autopay feature, that will pay your minimum monthly payment as soon as your statement is posted. Figure out how to leverage this feature with your credit card company, and turn it on as soon as you can. Why risk it?
Habit #4: Cash Advances Don’t Exist
When it comes to credit card usage, treating cash advances as if they don’t exist can save you a significant amount of money in interest and fees. Unlike standard purchases, cash advances often come with higher interest rates and begin accruing interest immediately, without the benefit of a grace period. Additionally, many cards charge a separate cash advance fee, which is typically a percentage of the total amount of cash taken out.
In our post on credit card statements, you could see that one of my credit cards accrues 9% more in interest on a cash advance. Ouch.
If you are ever in a dire situation and need cash quickly, consider other options that will likely cost you less. For instance, a personal loan generally has a lower interest rate than a cash advance and may even come with fixed monthly payments, making it easier to repay over time.
Habit #5: Check Your Balance Often
The last habit is to check your balance often, and accept that you should always be able to explain your credit card spending. This is another habit where you should take advantage of your bank’s offerings, as they likely have features to make this easier.
If you have a card with Wells Fargo, as an example, they offer impressive notification customization. You can choose whether to be emailed, texted, or notified via the app regarding anything from a single purchase to a summary of your day’s spending.
Final Thoughts
By incorporating these 5 habits into your financial routine, you can break free from the cycle of credit card interest. When used wisely, credit cards can absolutely work in your favor, providing a myriad of benefits without costing you a dime. Small, consistent positive behaviors can transform your credit card from a debt burden into a tool for financial growth.
