Using credit cards is a lot like investing in the stock market. They can be very rewarding, but there are a lot of pitfalls to avoid. Those who use credit cards wisely enjoy the convenience, security, and rewards that many cards offer. Those who don’t use plastic responsibly end up with a mountain of debt.
To help you stay on the right path, here are seven credit card mistakes to avoid.
1. Using a rewards card without paying off the balance each month. Rewards cards can put cash in your pocket with every purchase. Some of the best credit cards offer rewards in the form of cash back, airline miles, or points. If you play your cards right (pun intended), you can earn everything from free travel to cash that can be applied to your credit card bill every month.
If you don’t pay your card in full every month, however, rewards cards can be very costly. Because of the rich benefits these cards offer, they typically carry higher interest rates. These high rates can easily nullify the benefit of the rewards you may receive. So if you don’t pay your bill in full each month, consider a low-interest card over a rewards card.
2. Paying a balance transfer fee. Until recently, when you transferred a high interest balance to a 0% card, you were charged a balance transfer fee. These fees typically ranged from 3 to 5 percent of the amount you transfer. While paying this fee might still make the balance transfer a good option, today there are no-fee balance transfer options to consider. These cards typically carry a 0% introductory rate for up to 12 months. On a transfer of $10,000, these cards could save you as much as $500 in transfer fees.
3. Paying a monthly fee on a prepaid card. The prepaid market has grown substantially in the past few years. Fed up with ever increasing bank fees, many consumers are turning to prepaid cards as an alternative. In response, the fees prepaid cards charge have come down as competition heats up. But you still have to watch out for cards that sneak in unacceptable fees. The best prepaid cards might charge a monthly fee, but always give you an option to avoid the fee. And if they charge an activation fee at all, it’s less than $5. If you are considering a prepaid card that charges more than this, continue looking until you find a better deal.
4. Canceling a credit card without considering the effect on your credit score. Canceling a credit card might seem like a good idea, especially when you are trying to dig your way out of credit card debt. But before you cancel that card, consider that canceling your card may have a negative affect on your credit score.
A significant portion of your credit score is determined by the amount of available credit you have. Canceling a card will reduce the amount of available credit you have, and quite possibly lower your score. As an alternative, you can always cut up your card without canceling it. This is particularly important if you plan to apply for a mortgage, car loan, or other credit in the near future.
[See the Secret to Living Well on $40,000 a Year.]
5. Paying just the minimum payment each month. Most credit cards calculate your minimum payment as a percentage of your outstanding balance. While the percentage varies from one card to the next, 2 percent of your balance is common. Thus, on $10,000 in debt, your minimum payment might be only $200. While that may sound like a good deal, so did the horse that the Greeks gave the city of Troy.
Here’s the reality. A $10,000 debt at 15 percent interest and a minimum payment of 2 percent of the balance will take 32 years to pay in full if you stick with the minimum payment. And on top of that, you’ll pay more than $15,000 in interest alone. A better solution is to employ the “debt snowball” to reduce your credit card debt quickly.
6. Paying off cards with the smallest balance first. Trying to figure out which credit card debt to hammer away at first is a decision many struggle with. Some suggest paying of the cards with the smallest balance first. The idea is that by getting rid of some debts quickly, you’ll be more motivated to get rid of your the rest of your debt.
But what if your smallest debts also carry the lowest interest rates? If that’s the case, paying them off first is going to cost you much more in interest. The better approach is to tackle those cards that charge the highest interest rates first.
7. Ignoring little-known credit card perks. Credit cards offer many perks that often go unnoticed. These perks include things like extended warranties, purchase protections, and rental insurance. Many cards come with these special perks that protect the cardholder, but also save you money. The best part is that you don’t have to pay any extra fees to use these benefits For example, I used the extended warranty benefit when my printer broke. It was beyond the manufacturer’s one-year warranty, but my credit card extended that warranty by another year.