Tuesday, February 1, 2011

Day 111 - Step 10: Stop Using Credit Cards

February 2, 2011

I have developed a guide to help you (and me!) achieve the mindset and principles required to successfully become debt free.  This is the tenth in a series of posts about my Twelve Steps to Debt Freedom.

Step 10: Stop Using Credit Cards

Although you have completed the first nine steps, I will bet that the tenth step will be more difficult than it first sounds.  I believe that this step is also very crucial to your long-term success.

My Credit Card History
When I was a sophomore in college, I applied for and received a credit card.  I figured this would be a great thing to have in case of an emergency especially since my parents didn't have much money.  Of course, emergencies in college for me usually equated to some type of alcoholic beverage, new clothing or a last minute road trip to Las Vegas.  I also figured out that if I went out to eat with some friends and paid for everyone with my credit card, they would in turn hand over cash and I would end up with some spending money.  Pure "genius" - or so I thought.

After college was over and I entered the workforce, I would diligently make my minimum monthly credit card payments.  I also would use my credit card to pay for almost everything with the intent of paying it off every month.  My justification for using my card was so that I would have money in the bank in case of emergency and also so I could earn points with my purchases.

Prior to the credit card companies raising their interest rates a few years ago, I decided to stop using credit cards altogether and  pay everything off.  As of today, I have no credit card debt and have canceled all but one credit card.  Over the past ten years, my credit card debt balance has been anywhere from $500 to $18,000.

Mistakes I Made
Thinking Credit Cards Create Security.  I think many people believe - and credit card companies encourage - the thought that credit cards create a great safety net if $h!t hits the fan.  I definitely bought into this mindset and would rely on my credit card if my car broke down or I had any type of large expense rather than contributing money consistently to an emergency fund.  Let's take a look at this a different way: suppose you have an emergency expense that costs $1,000.  You charge this expense on  your credit card which carries a 25% interest rate and plan to pay $100 a month until it is paid off.  At this rate, it will take you 12 months to pay off and you will end up paying $200 in interest.  That is one expensive loan!  Consider the alternative - you decide to put $100 a month into a savings account for emergencies.  Although you won't make much money since interest rates are ridiculously low, you would eventually build up a balance to use for emergencies.  Next time you have that $1,000 emergency it won't end up costing you $1,200.

Credit Card Points Justify Use.  Many people, including myself, justify credit card use by signing up for some kind of points reward system.  I am still signed up for American Express Rewards and wondering now if it is really worth it.  My Rewards membership costs $95 a year.  For every $1,000 I spend, I receive what is the equivalent of $10 to spend through the Rewards system.  Therefore, just to break even and earn back my membership fee I need to charge $9,500 on my AmEx.  Charge any amount less than that and you are basically losing money.

What I Have Learned
Be Aware of Spending Behavior. I have realized that I am not the kind of person who can responsibly pay off my credit card debt each month.  I also feel there are better ways to manage my money than to use a credit card that bases its fee structure on the odds that you will screw up and make a late payment or charge too much to pay off at once.  I have read the comments section of other bloggers who have discussed credit card usage and noticed many people preaching about paying your balance off every month as if people who don't are just idiots.  I say kudos to the balance payers but it just doesn't work for me.  And you shouldnt be reading blog postings about credit card usage just so you can post a nasty comment because you don't have that problem.

Read the Terms and Conditions.  Mike and I were reading about the terms of his credit card the other day and the fees they have the capability to charge are pretty ridiculous.  One late payment results in an increase to a 29% interest rate.  If you use the card abroad, they not only charge you a fee EVERY TIME (this is new) you swipe it but they also get to determine the exchange rate for that purchase as they see fit.  Spend a few minutes reading that fine print - you will most likely be disgusted.  If I told you I would loan you $800 at 29% interest would you take that deal?  How is using a credit card any different?

Estimate Your Payoff Time.  I think you will be surprised at the amount of time it will take you to pay off even the smallest balances if you continue to make minimum payments.  Even worse is the total amount of interest you will pay over the payoff timeline.  There are many websites that provide a tool so you can calculate how long it will take to pay off a credit card and how much interest you will end up paying.  Start thinking in terms of total payoff amount rather than monthly payment amounts.  Here's a good example: I used the Federal Reserve's calculator to see how long it would take to pay off $10,000 if I made only the minimum payment and had a 19% interest rate.  It estimated 54 years to pay off and about $35,000 in interest paid!!!!  Yowzers!!

Bank Rate Calculator
Federal Reserve Calculator 

Hopefully you and I can both learn from my past credit card experiences and figure out that credit cards are not all they promise to be.  Credit card debt should not be the norm.

Read About Step 11:  Reassess 

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