Paper or plastic? The decision to use cash or credit can invoke strong opinions. Here at Ninja Piggy, I try to take a rational, pragmatic approach to financial decisions. I realize the rewards, benefits and convenience of using a credit card may be too enticing to pass up. Instead of telling you to use cash because credit cards are evil, I lay out guidelines to follow if you do decide to use a credit card.
I personally use a credit card for pretty much everything, so, even with the risk in using a credit card, I wouldn't be comfortable telling everyone they couldn't use one (I'm not better than everyone else). There are many benefits to using a credit card, but doing so can be extremely risky to your finances. For the people who decide to use credit cards, I recommend you follow these rules:
Never carry a balance
Don’t use a credit card if you haven’t paid off your credit card in full every month for the past two years
Build a budget before using a credit card
Carefully Monitor Your Spending
Stop using the credit card if your spending gets out of control (this can happen even if you are paying it off every month)
Determine what credit card rewards are best for you
Evaluate Your Credit Card Fees
Be Mindful of Your Credit Card Limit
Be Careful!!! Using credit cards can be like playing with fire. If you aren’t careful you will get burned
Below is additional information and reasoning behind the credit card rules:
1. Never carry a balance
Carrying a tree is cool. Carrying a balance isn't. According to a 2015 study by creditcards.com, the average APR on credit cards is around 15%. 15%!!! Any investor I know would sign up for a guaranteed 15% return in a heartbeat. Avoid paying interest by never carrying a balance. I have yet to meet a person who will admit to carrying a balance on their credit card (except those who are in the process of aggressively paying down debt). Banks are getting rich off of somebody. Someone is paying the interest. Make sure it isn't you.
2. Don’t use a credit card if you haven’t paid off your credit card in full every month for the past twelve months
With sky-high interest rates, credit cards are a terrible deal if you aren’t paying them off every month. There are some great benefits to using credit cards if you can use them responsibly.
How do you determine if you're responsible enough? One great test is to look at whether you’ve carried a balance in the past year. If you've carried a balance in the past year you've demonstrated irresponsibility with your credit cards. Take a one year break from credit cards and use cash or a debit card.
Don't make excuses here. I'm sure you have a good explanation of why you carried a balance. It doesn't matter. You need to take a break from using credit cards. Quit using the credit card for a year, and focus on building up your savings to prevent carrying a balance in the future.
3. Build a budget before using a credit card
Credit cards are literally begging you to overspend. Take the first step of defending yourself by establishing a spending plan or budget.
4. Carefully Monitor Your Spending
It’s one thing to build a budget, it’s another to follow the budget. Track your spending and compare it to your budget. Make sure you aren't spending more than you planned on spending.
5. Stop Using the credit card if your spending gets out of control
If you’ve followed steps 3 and 4 then you should know when your spending is getting out of control. One common mistake people make is thinking they aren’t overspending because they are paying off their credit card every month. If your spending isn’t in line with your budget, stop using the credit card. Freeze it in an ice block. Lock it up. Cut it up. Do whatever you need to do to stop using the credit card and get your spending under control.
Credit card rewards can make you feel good about spending. You feel like you are being smart every time you swipe your card because it puts you that much closer to the trip you've been planning with your reward points. Don't fall for this mindset. If your spending gets out of control, stop using your card. 2% cash back when you've overspent by $100, still puts you behind $98. It isn't worth is to overspend.
6. Determine What Rewards Are Best For You
I’m a travel rewards guy myself, but I realize not everyone is a traveler. There’s no sense in using a travel rewards card if you will never use the rewards. Go with the card offering the rewards that suit you best. Maybe a cash rewards card.
7. Evaluate Your Fees
Notice I said evaluate, not eliminate. Some cards offer great rewards but come with an annual fee. Determine if you are getting enough value from the annual fee you are paying. Try calling your credit card company to negotiate down your annual fee (not every credit card issuer will lower it, but it's worth a shot).
I recently signed up for a card with a $450 annual fee. Crazy, right? Actually, the card offers tremendous rewards far exceeding the fee I’m paying. It's okay to pay an annual fee, just don’t pay unnecessary credit card fees.
8. Be Mindful of Your Credit Card Limit
One of the factors used in determining your credit score is your credit utilization ratio. The ratio looks at how much available credit you are using. If you have a $10,000 credit limit and a $4,000 balance you have a credit utilization ratio of 40%.
Try to keep your ratio under 30%. Increasing your credit limit, and/ or decreasing your spending can help with this. You can also pay your credit card off multiple times throughout the month to decrease your credit utilization ratio.
9. Be Careful!!! Using credit cards can be like playing with fire. If you aren’t careful you will get burned.
Credit cards aren’t for everyone. While there are some great benefits to using a credit card, I don’t think credit cards are appropriate for everyone. If you can’t follow these guidelines, you shouldn’t be using credit cards. If you are perfectly content using debit cards or cash, stick with what you are doing.
Remember, someone out there is paying those outrageous credit card interest charges. According to nerdwallet, the average U.S. household carries $15,310 in credit card debt. Credit cards can destroy your life! Credit cards can be responsibly used, but you are playing with fire. If you aren’t extremely careful, you will get burned! Be careful!