About 30 years ago, after graduating from college, I applied for my first credit card, and then I soon applied for a second one, and I did utterly stupid things with them.
Learning from your mistakes is great and important, but when you can learn from other people’s mistakes, that’s even better.
My hope is by broadcasting my past stupidity, I can save you from making some of your own stupid mistakes. I can’t save you from all of the stupid mistakes you’re going to make – and we all make them – but maybe I can help you use your credit cards more carefully.
In my early 20s, my younger brother came to me and asked me to pay off a debt he had. He was starting his own company – a pie business. My brother was 21, and I was 23. He owed a bakery $5,000 for a lot of pies they’d made, but he didn’t have the money to pay them. And they wanted their money, like now. (His ambition was admirable, but he was way in over his head.)
My brother was too nervous about going to our parents to get financial help, and he came to me instead. He knew his older brother had just applied for a second credit card.
“I’ll pay you back,” he promised.
He was sincere, and to his credit, he did pay me back… When we were in our 30s.
Not that he didn’t try to pay me back sooner. For close to a decade, my brother, whose pie business never got very far, shoveled money to me, to pay off the credit card. But it was usually the minimum payment, which meant he was barely paying off anything. Furthermore, there were many months that he couldn’t make payments, so I’d have to make them.
I could go on, but you get the idea.
Granted, it might have worked out fine, if his business had worked out, or if I was a 23-year-old attorney making a ton of money and could afford to lend him $5,000. I was a magazine writer making $19,000 a year, lending money to an aspiring entrepreneur with no steady income.
What’s really sad is that I didn’t have this second credit card for any reason other than my alma mater sent me an application and suggested I apply for their credit card. I loved the idea of having my college logo, Indiana University, on my credit card, so I applied. Was I thinking about cash back offers? Welcome bonuses? Was I thinking of a credit card as a helpful cash flow tool when I was between paychecks?
I made other financial blunders in my 20s. Around the same time, I bought an expensive car that I didn’t realize I really couldn’t afford. But when you couple this credit card error with my other mistakes… well, it’s a wonder I didn’t wind up somewhere in a debtor’s prison before I was 30.
There are several negatives with credit card cash advances. For starters, the moment you take cash out against your credit card limit, the interest kicks in. The wonderful thing about buying anything on credit with a credit card is that there is no interest until your payment due date. If you make the full payment by that date, there’s no interest at all. None. You’ve just been given an interest-free loan.
Not so with cash advances. The interest starts immediately, and worse, there’s often a higher APR for cash advances than for purchases you make with your credit card.
Also, if you’re in credit cards for the rewards, remember you won’t earn them on cash advances, so that’s another thing to consider. There’s just very few advantages to taking a cash advance.
If cash advances are so terrible, why do credit cards offer them? Because if you truly have a financial emergency where you need cash immediately, yes, cash advances are very helpful for the consumer. And you’ll be glad that credit cards offer them.
But if you are not in a true emergency, stay far away from cash advances. I remember taking them out on occasion, having a vague understanding that it wasn’t a great idea, but I took the cash, anyway.
One further point of clarification, the term “cash back credit cards” does NOT mean you can get cash back when you buy something like you can a debit card. Even cash back credit cards will consider it a cash advance if you withdrawal cash from an ATM or from a bank teller with your card.
If you can avoid cash advances, avoid them. I’m confident that your future self will thank you.
I think everybody knows this, but if you’re low on cash, it’s tempting to make only the minimum payment. Of course, if you’re really low on cash, you may not have any choice, and I get that. If that’s all you can do, make the minimum payment and take it as a win. Importantly, making the minimum payment at least protects your credit score.
But if that’s all you can do, month after month, you’re hurting yourself in the long run since you’re barely paying off your debt.
Some credit cards come up with the minimum payment by charging you a percentage of your total statement balance, including interest and fees, so that you’re paying between 1% and 3% of what you owe. If you owe an especially large amount, that’s likely how your issuer will calculate your minimum payment.
Your credit card issuer may also require a fixed dollar amount as a minimum payment, often $25-$40, and that often happens when you owe something, but not an astronomical amount.
That alone should give you pause. Every time you pay your credit card a minimum amount due, you’re only paying a tiny fraction of what you owe and, depending on your balance and interest rate, you may be mainly paying off interest charges and not actually making a dent in debt principal.
Just making the minimum payment means you’re going to stay in debt for a long, long time. Furthermore, you’re going to end up paying much, much more for your purchase that it’s original price thanks to interest charges.
Make only minimum payments — or any size payment that doesn’t completely pay off your statement balance — and you will carry revolving debt.
Look, if your car goes to the mechanic, and you put $900 on your credit card to get your brakes fixed and then take three months to pay that off (or even four or five), don’t beat yourself up. It would have been better if you had an emergency fund that you could have tapped into and used to pay off your credit card bill in the first month. In that case, you could have used a cash back credit card on that $900 purchase and earned some rewards. In the end, using your credit card to get you out of a financial jam like repairing a car is an understandable thing to do.
It’s when you use your credit card to routinely spend above your means that you can run into serious trouble.
As a general rule, carrying revolving debt is bad for a variety of reasons.
- You’re paying interest every month, until the debt is paid off. If you spend $900 on a credit card in any given month and pay it off before your due date, as I noted earlier, you have taken out a $900 loan and paid zero dollars on it. If you spend $900 on a credit card, however, and you only make the minimum payment of $22.50 (assuming it’s 18% interest plus 1% of the balance), it would take you 102 months (eight and a half years!) before your debt would be paid off. In which time you’ll have spent $773.12 in interest… for a $900 expense.
- You’re hurting your credit score. If you carry too much revolving debt, you can hurt your credit utilization ratio, which is a fancy term that refers to how much credit you have – compared to how much you’re borrowing. If your credit line is $1,000, and you put $900 on your credit card, you’re almost maxed out — you’ve borrowed 90% of what you’re allowed — and lenders don’t like that. A high credit utilization ratio can damage your credit score. If you’re always carrying a lot of revolving debt, your credit utilization ratio is always high, so your credit score may be progressively getting worse. Aim to keep your utilization below 30% if at all possible.
- You have less money to spend. This may be the cruelest cut of all, especially if you’re really struggling. If you’re constantly shoveling money every month to your revolving debt, that money could be going to anything else, like a future vacation or maybe clothes or movie tickets or concert tickets or a gazillion other things you might like. But, no, it’s going toward your past vacation and the running shoes you’ve already broken in and are already thinking of replacing.
There are different forms of ignoring your credit card debt. You can completely ignore it – and stop looking at credit card bills and stop making payments. But if you’re only making minimum payments and not thinking all that much about how that revolving credit card debt is growing, which was often my problem, you’re also ignoring it.
I don’t think I ever ignored my credit card debt in my 20s. I was never not aware of it. But I often wasn’t fully aware of mistakes I was making, month after month, year after year. For instance, if you’re working hard to pay down revolving credit card debt, don’t use that same credit card to make purchases – at least, if you can help it. Because adding to your debt while you’re paying it off isn’t helping you get out of debt.
Of course, there are so many other mistakes you could make with your credit card, many of which I’ve also made.
I’m sharing none of this to convince you that credit cards are bad and that you should run away from them screaming. In fact, quite the opposite. As I eventually discovered, if you use credit cards correctly, they are phenomenal financial tools, and they’ll make you richer, not poorer.
By showing lenders that you’re using your credit cards properly, your credit score will go up and stay up, and you’ll get better (ie. lower, cheaper) interest rates on other loans, like a mortgage and a car. If you make your payments every month, and you have a credit card that offers rewards such as cash back, points or miles, you can save money when you redeem those rewards.
But if you don’t have a lot of money coming in, you can’t spend first and ask questions about how you’re going to pay the credit card back later. Because if you can’t pay your credit card now, you may pay dearly for it later.