(Guest Post by Benjamin Feldman)
Credit cards are so common these days that it seems perfectly normal to pull one out and swipe it at the gas station, the grocery store, a restaurant, or anywhere else. It’s more convenient than using cash, and there are several other benefits (such as rewards, building credit, enhanced security) that seem to make it worthwhile.
But is using credit cards as harmless as it seems?
Not necessarily. The truth is, credit card usage depends upon your individual personality and your relationship with money. For some people, using credit cards can in fact be dangerous. Why? Because the cards might make it too easy to spend more (perhaps way more) than what you can really afford.
Consider that the credit limit on many credit cards ranges anywhere from $3,000 up to $30,000. With that kind of debt available at your fingertips, there is a very real possibility of spending yourself into a massive financial hole. When you realize that many Americans have little to no savings in the first place, it’s easy to see how credit cards can pose a problem for anyone. Balances can start small and innocent but creep up over time, and before you know it you’ve got a problem on your hands.
So how do you know if you are using your cards the right way or the wrong way? Read on…
How to Tell If You’re at Risk
The way credit cards can hurt your finances is by making spending too easy. That means, even if you think you’re a responsible credit card user, you may be buying things more frequently (or at higher prices) than you otherwise would.
For example, I realized earlier this year that my credit cards were making it too easy for me to eat out (for lunch during the week and dinner on the weekend). It felt like a small indulgence but I rationalized it and the credit card made it easy to carry on without confronting the real cost of my eating habits. When I finally took a hard look at how much I was spending on food, I was shocked.
That’s how credit cards can trick you.
Even the most diligent of us can get fooled – or lulled into thinking we’re being very frugal when in reality we’re letting some unnecessary expenses slip through the cracks each month. Remember, part of the problem is that you think your spending is okay. So we need some alternative ways to check ourselves.
If you’re already using credit cards, here are several exercises you should try that will give you insight into whether you should be worried about them compromising your finances:
Audit your savings and emergency fund: How much money are you saving up each month? Ideally, you should identify a certain percentage of your income as a goal and then try to set aside that much every month in a savings account or investment account. If you haven’t been saving at all, that’s a red flag that could indicate a potential problem with credit card spending. If you have been saving, that’s a good sign, but is it enough? Many experts recommend saving at least 10% of your income per month. If you’re well short of that, it’s possible your credit card spending is the culprit.
Look back at your spending for last month: Print out your credit card or bank statement and go through all your spending for last month (or even the last 3 months). Tally up how much you spent on each category, like food, clothes, travel, entertainment, etc. Once you’ve got the totals in front of you, it’s time for a gut check. Is this a reasonable amount, or are you overspending? If the totals seem high, that’s another red flag.
Try using cash for a week: Take your credit cards out of your wallet or purse (or vow not to use them) and get enough cash to cover all your expenses for a week. Then track your spending during the week and, more importantly, track how you feel about your purchases. If it suddenly feels harder to spend money, or if you spend less than usual, that’s a sign that credit cards are distancing you from the ‘pain’ of spending. And that’s another red flag.
If you’re seeing several red flags, then there’s a good chance your credit cards are dangerous (or at least a hinderance) to your long-term financial health. But if that’s the case, don’t worry – you’re not alone. And there are some concrete steps you can take to avoid credit cards.
What Alternatives Are There?
Okay, so let’s say you did the exercises in the steps above and realize you do have a credit card problem. What can you do? Well, luckily, there are some alternatives to using credit cards.
The most obvious alternative is to permanently switch to using cash. But it doesn’t need to be as basic as simply taking out cash from the ATM whenever you run out and need to buy something. Instead, try using the envelope system. The envelope system works like this: at the beginning of each month (or week) you withdraw enough cash for that time period. Then, you divide the cash amongst various envelopes, according to your budget. For example, if your budget looks like this:
Eating out: $100
You would take out 5 envelopes, write a different category on each one, and put the corresponding amount of money in each envelope. Each day, you take enough money from each envelope to pay for the things you’ll need during that day. This way, you know exactly what you are spending money on, and there is no way for it to disappear unexpectedly on things you weren’t planning to buy.
Another alternative is to use a debit card instead of a credit card. You put limited money in the debit card account each month, and when it’s gone you don’t get to spend anymore. In fact, you can use a hybrid version of the envelope system described above by simply keeping a tally of your expenses throughout the month.
With debit cards, you can have the convenience of plastic payment without the hassle of carrying cash – and without the risk of running up debt. Of course, for some people the positive psychological effect of using cash (greater awareness of your spending) may not be felt as strongly with a debit card. But theoretically it should have almost the same impact.
The good news is now that you’ve identified whether you have a problem with credit cards, you can take action if necessary to help your financial picture improve!
One last bit of advice: if you already have debt on your credit card, you should immediately calltoseeifyoucanloweryourinterestrate(s). That move alone could end up saving you hundreds of dollars in finance charges. Also, for more money-saving tips, check out the ReadyForZero resource centers on CreditCardDebt and BudgetingTips. And when you’ve paid off the credit cards, remember not to close the accounts (unless you think you’ll continue to be tempted) because doing so will hurt your credit score.
Best of luck!
Benjamin Feldman is a personal finance expert at ReadyForZero, a visually-compelling web app that helps people get out of debt (for free) by giving them a plan and motivating information – like how much interest they’re paying per day. Follow him at @BWFeldman and read more of his work at the ReadyForZeroblog.
Photo by images of money