Are you struggling with credit card debt and looking for ways to avoid it? Well, you're not alone!
Many people face the same problem and find it difficult to manage their finances. Fortunately, with a few smart tips, you can take control of your credit card debt and achieve financial success.
In this article, we will talk about what is credit card debt and how it works and share six tips that can help you avoid credit card debt and improve your financial well-being.
What is Credit Card Debt and how does it work?
Credit card debt is the amount of money you owe a credit card company.
Here is how it works:
- When you use your credit card to make a purchase, you are essentially borrowing money from the card issuer.
- You then have to pay back that borrowed amount, plus any interest or fees that the issuer charges, by the due date on your statement.
- If you don't pay off your full balance each month, your credit card debt can accumulate over time. This can result in high-interest fees, which can make it difficult to pay off your debt.
Calculating Your Credit Card Debt
Calculating your credit card debt offers a clear picture of your interest and the duration it would take to pay off the debt.
There are now many online calculators that you can use. You will also get a clear picture of how much you spend versus how much you should use.
6 Tips to Stay out Of Credit Card Debt
Credit card debt can snowball out of control if you are not careful. If you find yourself struggling with credit card debt, there are strategies you can use to help you get back on track.
1. Set a Budget and Stick to It
Budgeting helps you avoid spending more than you can afford. You need to identify how much you earn and what your expenses are. When you know how much you are spending, it is easier to avoid falling into credit card debt.
When creating your budget, make sure to include all sources of income and all your expenses and track your spending.
To do this, you can either use a budgeting app or create a spreadsheet. Make sure everything fits into a specific category in the budget.
Additionally, consider setting aside some money for unexpected expenses or emergencies. If possible, save at least 10% of your income each month. Regularly revisit and adjust your budget based on income or expenses change.
Some examples of expenses include:
- Food
- Rent/mortgage
- Insurance
- Transportation (gas or public transport)
- Utilities
2. Use Credit Cards Responsibly
To avoid getting into credit card debt, it's important to use your card responsibly.
This means only using your credit card when you can afford to pay it back in full each month, and making sure to always make the minimum payments on time.
Responsible credit card use can be a valuable asset to your finances. Unlike cash, cards are accepted almost everywhere, making them a convenient purchase method. However, you may get into debt on your credit card if you do not control your spending habits.
Impulse buying is a massive culprit of overspending because you make decisions based on emotion. Consider leaving your credit card at home and paying cash when shopping for non-essential items.
With a credit card, you can make purchases that may be out of your immediate financial reach and then pay them back over time.
Credit cards also offer several security benefits:
- If you lose your card, you can report it and have it frozen, reducing the chances of unauthorized transactions. Also, many credit cards offer protection from theft, loss, or damage of goods purchased.
- Credit cards can be an excellent way to build your credit score. When you use a credit card responsibly, you prove that you are a trustworthy borrower. Making timely payments indicates you can be trusted with credit. As a result, your credit score will improve, making it easier for you to access credit.
- Credit cards also have reward programs that allow you to earn points or cash back for every dollar spent. These rewards credit cards can add to significant savings if you frequently use your credit card.
3. Build an Emergency Fund
An emergency fund can be the key to financial stability when unexpected situations occur. It is a stash of funds allocated to unforeseen expenses, such as:
- Medical bills
- Car repairs
- Job loss
Emergencies can happen to anyone, anytime and anywhere. For example, a sudden job loss can occur due to unforeseen circumstances, such as company restructuring or downsizing. Similarly, health issues can strike unexpectedly and profoundly impact your finances.
Without an emergency fund, you can find yourself under a significant debt burden and tempted to use your credit card to stay afloat.
Doing so can quickly increase your debt-to-income ratio, negatively affecting your credit score. The fund thus provides a safety net to help you cover your living expenses.
How to build an emergency fund
- You must determine your monthly expenses and calculate how many months of living expenses you want to include. Experts suggest keeping six months' worth of expenses aside
- Evaluate the high-priority items that require immediate attention in an emergency. You can open a separate bank account and make regular contributions through direct deposits.
- Ensure the funds are liquid enough to be easily accessed without penalties or charges. Remember not to compromise your long-term savings or financial goals.
- You may also use tax refunds or bonuses to add funds to your emergency savings account can jump-start the process.
4. Keep Away From Credit Card Cash Advances
A credit card cash advance is a type of transaction that allows you to withdraw cash from an ATM or bank using your credit card, rather than using your debit card or withdrawing money from your checking account.
Though convenient, they can lead to steep fees, high-interest rates and hurt your credit score:
- Most credit card companies charge a 5% fee on cash advances, which is significant when you withdraw large amounts on your card. So, if you plan to take out a cash advance of $1000, you'll need to pay an additional $50 in fees alone.
- Cash advances come with higher interest rates than those charged on regular purchases. That is because cash advances are riskier transactions and don't have the same level of protection. Some credit card companies may charge an interest rate of up to 25% or more on cash advances. That means you could owe much more if you take out a cash advance of $1000 and don't pay it off immediately.
- Cash advances can also hurt your credit score. This is because cash advances are counted toward your credit card utilization ratio.
5. Keep A Low Utilization Ratio
The credit card utilization ratio is the amount of credit you're using compared to the amount of credit you have available.
A low utilization ratio helps you avoid credit card debt because when you have a balance on your credit card, you must pay interest on that amount.
You can avoid accumulating high debt and reduce the interest by keeping your utilization low. This can save you money in the long run, resulting in a better financial situation. Here's how:
- The most straightforward strategy to keep a low utilization ratio is to pay off your balance in full every month. This way, you are using your credit card as a tool rather than as a source of debt.
- Additionally, consider increasing your credit limit if you use more than 30% of your available credit. That will lower your utilization ratio without changing your spending habits
- Be sure to spread your purchases across different cards and keep each card's utilization ratio below 30%. This keeps your utilization ratio healthy and makes it easier to manage your spending.
6. Refrain from Extraneous Balance Transfers
Balance transfers have become a popular way to manage credit card debt. They allow you to move your credit card balance from one card to another with a lower interest rate.
But before you jump into a balance transfer, you should understand the dangers of this strategy and why you should probably avoid it:
- Balance transfers can be costly: Many balance transfer cards offer a 0% introductory interest rate for a limited time, often between 12 and 18 months. After that, the interest rate jumps back up, sometimes exceeding the rate you were paying on your old card. Additionally, most balance transfer cards charge a fee for the transfer, which can negate any savings.
- Balance transfers also have the potential for misuse: Moving your balance to a new card doesn't lower your debt; it changes the terms of the debt. It's critical to avoid adding new charges to the card if the goal is to get out of debt. Carrying a balance and making new purchases will only make the debt grow.
- Balance transfers can negatively impact your credit score: When you apply for a new credit card, a hard inquiry is added to your credit report. Additionally, closing your old credit card can affect your credit utilization ratio. If you have a high credit limit and transfer your balance to a card with a lower credit limit, you increase your credit use ratio. That can also lower your score.
- Balance transfers can be harmful if you don't pay off your debt: After the introductory period, you will still be in debt if you transfer your balance to a 0% interest card and continue with only the least payments. That will leave you with a new debt burden and hamper your financial success.
Conclusion
In conclusion, learning how to avoid credit card debt is a vital financial skill. You can avoid debt by creating a budget, using your credit cards wisely, building an emergency fund, and keeping your credit utilization low.
Also, avoid extraneous balance transfers and cash advances. Remember that your credit score is essential to your financial future.