Should I use my credit card during holiday season?
Question: I have been busy the past few days and I haven’t bought my Christmas gifts yet for my friends and loved ones. I am running low on my cash as I am also planning to host a Christmas party in my house and go on vacation next week. Should I use my credit card to pay for my purchases?—Tonie by e-mail
Answer: Yes, you can use your credit card if you can afford to pay your balance in full when it falls due next month. If you have the capability to raise the cash and settle your credit card debt without affecting your personal cash flow needs, go ahead. However, if you are planning to pay your credit card balance by the minimum every month, you may be setting up yourself for financial trouble.
Credit cards are great source of free credit when it is used properly. It offers a convenient substitute to carrying large amount of cash when you go shopping. The key is to avoid tolerating credit card companies make money from you from interest charges. When you pay the suggested minimum payment, you already agree to pay interest to them at an unreasonably high rate. For example, there is one credit card company that charges interest rate of 3.25 percent per month. Do you know that this translates to 39 percent a year? This is huge compared to the average cost of money of the bank that pays only 0.5 percent savings rate a year. This same company offers you to pay super-low minimum payment of only 1 percent of your credit card balance. Imagine this, you pay monthly minimum of only 1 percent that is not even one-third of your interest cost of 3.25 percent. Does this sound like a good deal to you? Well, beware.
If you follow this by paying the minimum, the difference will be simply added to your balance. The longer it takes, the bigger your debt balance will become as your unpaid interest accumulates over the months. In fact, for as long as the minimum payment is lower than your interest, it will take you forever to settle your debt fully. For example, you spent P75,000 for your purchases this Christmas and you plan to pay the minimum of 1 percent or P750 every month on due date because this is what you can afford. Do you know that if you pay this monthly for the next 30 years, your total credit card debt will balloon to P225 million? You would have already spent P7 million on interest charges alone! By the way, if you want to get a copy of credit card payment calculator, please go to www.rfp.ph/downloads.
So how do you avoid getting into trouble with credit card? Sometimes it is so easy to lose track of your spending when you are using your credit card on small purchases only to discover after a month that you have already accumulated a large debt that you can’t afford to pay at once. To limit your risk on credit cards, here are my tips for you:
Avoid carrying too many credit cards. As much as possible, limit the number of credit cards to one or two because the more credit cards you carry, the more you will be tempted to use them all. You can use one credit card for regular purchases like groceries, utilities and other fixed expenses that you would otherwise pay by cash. In this way, you can keep a record of all your household expenses for budgeting in the future. You can use the other credit card for big-ticket items such as laptop, LED TV and others, which you purchased on zero-interest plans.
Request lower credit limit. Sometimes credit card companies will upgrade your limit even if you don’t ask for it. They will even offer your cash advance using your credit card. They want you to borrow money and pay at minimum because this is where they earn a fortune. Don’t fall into their trap. Lower your limit to avoid temptation of overspending.
Control your spending to 30 percent of your credit limit. If you have good self-control, you can try limiting yourself within the 30 percent of your credit limit. Once you have reached certain amount, you can stop using your credit card. One option to help you control your credit card spending is to use a debit card. Use debit card for purchases and combine it with credit card on some occasions with your self-imposed limit in mind.
Don’t use your credit card to buy things you can’t afford. One fast way to get bankrupt is to live a borrowed lifestyle on debt. If you can’t afford to pay it today, it is possible that you would not be able to afford it also next week or next month.
Don’t pay more than the minimum. Pay more than the interest per month. If your interest is 3.25 percent a month, try to pay at least 5 percent. If you have extra cash, you can pay 10 percent or more. This way, you are able to lower your principal balance instead of increasing it. The lower your principal, the sooner you can settle your credit card debt. Preferably, avoid this situation. Always paying in full is the best solution.
This holiday season should not be an excuse for you to overspend using your credit card, thinking that you have one whole year to repay. Start the year right. Always plan ahead things that you want to buy on credit and do not fall into the traps of the credit card companies. Use your credit card wisely and have a happy holiday!
Henry Ong is a registered financial planner of RFP Philippines, the premiere professional body of financial planners in the Philippines. You can e-mail him for comments and questions at [email protected] To know more about becoming RFP, visit www.rfp.ph or inquire at [email protected].
