People who use credit cards can be separated into two groups. The first group, Type A credit card users, use credit cards because they don't have cash available in their bank accounts to pay for purchases they need or want. The second group occupies the other side of the spectrum. They use credit cards as a tool for convenience, buy only what they can afford, pay the bill in full every month, and possibly earn credit card rewards for everything they would have otherwise purchased with cash. These Type B credit card users are rare.
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Because they spend more than they can afford, many Type A credit users should seek to change their habits. These over-spenders could improve their financial well-being and net worth by following these ten simple – though not necessarily easy -- steps.
1. Track your spending for at least one month. It may require some effort to write down every dollar that leaves your wallet and every purchase you put on your credit card, but paying attention to these details often shed some light on something that you would much prefer leave hidden. The first time you see the hundreds of dollars you spend every month eating in restaurants, for example, could provide the shock necessary to start taking your finances seriously.
2. Be aware of marketing. Companies spend a good percentage of their profits learning how to get customers like you part with their hard earned dollars. They don't care if you have the money to spend, because freely available credit means they can sell you something whether you can afford it or not. It's impossible to be completely above the influence of advertising, but being aware of how companies target you puts you in a better position to control your spending decisions.
3. Commit yourself to change. Logic and reason often play only small roles in decision-making. If everyone made choices based on their financial best interest, more people would be wealthy. Some of what you might see after step 1 and step 2 above might help convince you that you have the ability to end the cycle of debt and increase your net worth over time. You cannot change your behavior until you realize it is important to do so, much like a smoker may not decide to quit until they experience first-hand smoking's serious health effects.
4. Consolidate your balances. The above steps are mental while this and the rest are practical. Part of the problem is often disorganization that stems from having too many credit cards. Choose the card with the lowest interest rate and move all of your balances onto this one card. Call the customer service phone number on the back of the credit card and negotiate a fee-free balance transfer, using other options for transfers as leverage.
5. Enact a cash-only policy. Once your balance has been transferred, you can't use that card for spending. The balance on this card should be aggressively paid down with anything that you can afford every month. Don't use any of the credit cards which now have a zero balance, and stay away from using your debit card as well. It's psychologically similar to using a credit card, and at this point, all plastic should be avoided.
6. Destroy your credit cards. Get your free credit report from annualcreditreport.com to ensure you're aware of all the credit cards you may have, whether you have the plastic in your wallet or not. After ensuring your report is accurate, call each of the credit card companies for which you do not have a physical card and cancel the accounts. You may have heard that canceling old accounts could hurt your credit score -- ignore this for now. This process, at this time, is more important than your score. The only exception would be if you're planning to apply for a mortgage; if this is the case, keep your oldest card open.
For the remainder of credit cards on your report other than the one used for consolidation, shred the plastic and keep the accounts open. If your shredder doesn't handle credit cards, use a pair of scissors and discard the pieces in different locations.
7. Lock away your remaining credit card. As you won't be using this credit card for spending, keep it out of sight. Some people put their card into a cup of water in their freezer, locking their card into a block of ice. That might work for you. You will still be able to use this card in emergencies, but once the next step is complete, that won't be necessary.
8. Build an emergency fund. The first part of creating an emergency fund is opening a high-yield savings account. Many savings accounts allow you to create automated debits so you can save a portion of your paycheck before you realize you received the money. Talk to your employer to use this new account for direct deposit. The goal is to save 3 to 6 months of your expenses in this savings account. If you spend more than you earn just for basic necessities, you'll need to get creative. Remember: an emergency fund is for true emergencies only. This account should remain untouched for regular expenses.
9. Pay down your balance. When you consolidated your balances onto one credit card, the credit card company likely offered a lower minimum payment than the sum of all your previous minimum payments. This will help you complete step 8, but it also means that you have to work harder to pay off your debt. All of your available funds at the end of each month should be designated for your emergency fund or your credit card balance.
10. Check your progress monthly. Each month, you should see your bank account balance increasing and your credit card balance decreasing. Keep track of your progress whether with paper and pen, a spreadsheet, or software like Quicken. When you see this progress, recommit to spending only what you have.
When changing a behavioral pattern like overspending, don't expect immediate success. Our society encourages consumerist, and breaking from that trend is going to be difficult. We often do not see the consequences of overspending, but down the road, you will be able to see the effect on relationships as well as personal finances. Once you're ready to change, make the commitment and follow the steps above. Success will come through sticking to the plan.
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