Tweet This
One of my financial planning clients puts the family vacation on his credit card every year, then pays off the balance when he gets his annual bonus.
He and his wife want to take their grade-school kids to interesting places and spend quality time together while the kids are still at home.
However, since my client’s credit card interest rate is 8%, he's essentially paying an additional 8% for vacations every single year since he takes the vacation first and then pays off the credit card with his annual bonus the next year. After a few years, he’d have paid out enough in interest to pay for an entire trip.
The problem with using credit cards is that sometimes, you end up paying for purchases after you buy.
It’s expensive to carry a credit card balance. According to CreditCards.com, the average interest rate on a credit card with a balance was 13.51% as of February 2016. Cardholders who usually carry a balance had an average of $7,527 in debt as of September 2016.
If you were that “average” cardholder and you only made the minimum payment (4%) each month, you’d end up paying an extra $2,869 in interest by the time you paid off your balance, according to Bankrate’s minimum payment calculator.
When you pay off your credit cards and commit yourself to living credit-card debt free, you have more disposable income for all your financial goals.
Throughout my career as a financial planner, I’ve helped hundreds of people get and stay out of debt. I found the easiest way is through three simple steps:
Step one: Stop using credit cards.
You need to start paying in cash rather than borrowing. For online purchases, you can use PayPal, and at merchants you can use a debit card or cash. Another option is to use prepaid cards, such as Mastercard prepaid cards, Visa prepaid cards, or American Express Bluebird.
To make it work, however, you need to have a cushion of savings for when you have something unexpected come up, such as a car repair.
Step two: Make extra principal payments.
On your statement, lenders are required to show how long it would take to pay off your credit card if you only made the minimum payments. Since many of us are paperless now, we might not see it.
Remember that average balance-carrying cardholder, with $7,527 in debt and a 13.51% interest rate? It would take that person about 11 years to pay off their balance.
Even if you pay more than the minimum, interest can still be expensive. To stop the cycle of credit card debt, start carving extra money out of your budget every month to pay down your credit cards. Use a “pay off early” calculator to figure out how long it would take you to pay off your debt with extra principal payments.
By paying down your debt every month — not using your cards — you'll get there.
Step three: Save up for your goals.
In a recent post, I wrote about segmenting your savings by setting up a savings account for each of your goals. Just imagine: You are ready to buy new car, and you have a cache of funds set aside for a large down payment or for the car itself.
My client is now saving ahead for his vacations on a monthly basis instead of paying in arrears with his bonus. To jumpstart the new system, he took a moderately priced vacation this year and paid for it out of pocket.
You can do the same.
This three-step, get-out-of-debt concept is simple, but I never said it was easy. Swiping your credit card may feel easy, but it can be much more expensive in the long run.
Once you flip things around and “save to spend,” it becomes simple, easy, and inexpensive.
This article is part of a series: Reboot Your Finances in 2017
How To Completely Get Your Money Under Control This Year
