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Sunday, August 26, 2012

How to use your credit card properly

Most of us have got a credit card.  It is a useful tool for accessing large sums of money quickly. This, unfortunately is also the worst thing about it.  And since nobody is teaching us how to use a credit card properly, many people end up paying interest bills on their credit card every month.  They do this without getting the full benefits of the use of the card as it is usually at its maximum limit.

So for those of you contemplating getting a credit card for the first time, this is for you.

1. Your credit card is used to make purchases not to finance things.

That means, don't use your card to buy equipment for a business.
Don't use your card to pay University tuition fees.
Don't use your card to buy anything that will take many months to pay off.
Don't use your card to purchase shares or other investments.

Why not?

Because the interest rate is too high.  If you need large sums of money to finance your business, studies or investments, there are better loans out there.  Go and talk to your bank manager about getting a start-up loan and what these involve.  If they won't lend you the money, then that's probably as good an indicator as any that you shouldn't be spending it.

Do use your card for daily purchases like groceries.
Do use your card for anything you would otherwise pay cash for.
Do use your card for paying for haircuts and movies and clothes and restaurants.

Why?

Because it makes it so much easier to keep track of your spending.  At the end of each month you can look through your credit card bill and see exactly where your money has gone.  If you have spent $500 on take-away food in one month, you can assess this and decide if you should perhaps cut back on take-aways.  Also you can check your balance throughout the month.  I have a mental limit (not my credit card limit) not to spend more than $2000 each month (Total).  This includes groceries, bills, treats, everything.  If my balance on my card is $1850 on the 23rd of the month, I might decide not to bother grocery shopping at all until the first of the next month.  I'd use up all the rest of the food in the pantry first, even if it means going without bread or drinking powdered milk for a week.

2.  Pay your card off IN FULL each month.

Your card is used to make your life easier, not to buy things with money you don't have.  Your card should have an interest-free period.  This way, the first purchase you make on the card does not get charged interest until the following bill is due.  If you pay the balance of your bill (not the minimum payment) on or before the day that it is due, you will not be charged interest.

Why is this important?

Because otherwise you could end up paying $100 for that $50 shirt you just bought on special for $30. It's all well and good buying products on sale, but what's the point if you then go and put it on your card and pay interest on it?  $30 at 21% means that if you never pay your card off in full, by the end of the year you have paid $36.30 for that shirt.  Let's say you've maxed your card out at $2000.  At 21% you'll be paying $420 each year for NOTHING!!!  I can think of much better things than NOTHING to spend $420 on can't you?

3. Set yourself a limit.

Your credit card limit as directed by the bank should not be the limit you set for yourself.

Why?

Because life happens and you may still need money in an emergency.
Because the bank wants you to overspend so that they get the interest payment.
Because the bank will always give you a greater limit than you should set for yourself.

Decide on how much you can reasonably pay off each month.  Factor in the cost per year for car services, roadside assistance, electricity, insurance etc. Don't go over the limit.  Check your progress via internet banking each week to see how you are going.  If you are overspending, you can cut back.  If you get a particularly large bill in, your savings should be able to cover this.

Lets look at an example.

Say you are earning $4000 per month.  You are putting money into savings, rent and paying off a car so you decide that you can reasonably afford $2000 on the rest.  Your irregular bills (insurance etc.) come to around $5000 for the year.  So set yourself a limit on your credit card of ($2000x12-$5000)/12 = $1583 per month.  Round that down to make it easier.  Your credit card mental limit should be $1500 per month.  Don't spend any more than this except if you get one of those bills in.  Still put it on your card though, that's what it's there for.  When your credit card bill comes in, transfer the whole balance from your usual account onto your credit card.

4.  Don't get cash out on your card.

Why not?

Because it does not come with an interest free period.
You'll be paying interest on it from the second you have the cash in your hand.

What to do instead.

Let's face it, there are always things that are easier to pay cash for.  You don't want to have to spend $10 just so that you can put that $3 coffee on the card.  Instead, factor in some cash each month to your regular spending and get that out from your usual account.  Using our previous example, we have a $1500 mental limit.  Get out maybe $100 each month for cash transactions and reduce your mental credit card limit to $1400.  Once the $100 is gone, don't get any more out.  Or alternatively, if you have a night out planned with drinking and merriment, check your credit card balance, make a mental note to reduce your limit, get out what you think you'll need and don't go back to the ATM.

Any Questions?

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