Credit card companies provide an incredible service. You can spend money securely in shops and supermarkets across the globe, pay for things online, pay for holidays, be covered against fraud, get cash-back and receive many perks and bonuses. If you have some savings or are debt-free, a credit card is a very powerful free tool that adds to your financial independence. But if your expenditure starts to exceed your income, the temptation to use a credit card as an income stream becomes strong.
TRAP#1 Minimum monthly payments. Small payments are easy to make but give you a false sense of security. An average credit card would take many years to repay making only minimum payments each month. Some cards require you to pay only 1% – 2.5% each month, plus any fees and accrued interest. Making these small payments on time avoids late fees, but you won’t make any real progress in paying off the card. Meanwhile, you will be paying high rates of interest – typically 22.5% compared to a mortgage interest rate of between 2 and 4%!
TRAP#2 Interest-free balance transfers. Card companies offer great deals to make you switch provider. But they often charge a fee for doing the transfer. You only save if you are financially well-disciplined. The interest-free window is limited and if your card limit is increased, there is a massive temptation to spend like a drunken sailor (even worse if you spend on the old card).
TRAP#3 Credit card protection Insurance. This simply adds to your costs and fails to reduce the card balance. Plus there are so many loopholes in their payout criteria.
TRAP#4 Cash-back on purchases or other perks. Some cards may offer perks such as air-miles, but this can give a hidden incentive to use the card excessively instead of using cash, bank transfers or debit cards. Remember that the card companies want you to max out your limit and make minimum payments.
TRAP#5 Cash advances. If you are short of cash you can pop the card in an ATM and withdraw cash. However it comes with a hefty fee, plus you will end up paying heaps of interest if the advance isn’t paid off.
TRAP #6 The false sense of financial security. Having an available balance simply increases the temptation to spend. If you only have £20 in your pocket, then you are unlikely to take your secret Tinder date to an expensive restaurant. But if there’s £2000 left on your card limit, the temptation to spend is far too great.
In reality, every pound you spend costs you more if you have credit card debts because it’s one less pound that could go towards paying off the card and avoiding crippling compound interest.
A credit card is a tool that can be good or bad depending on how you use it. Use a card wisely and it can help you achieve financial freedom. But use a card irresponsibly and you could become a debt slave. Credit card companies make even more money from their struggling customers by charging late fees payment fees and interest. They secretly hate the disciplined customers who strive to pay off chunks or the balance in full each month.