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Your credit card will nickel-and-dime you to death — unless you do this.
If you don’t pay off your debt in-full at the end of each billing cycle, you offset any rewards you earn with interest charges. That’s true whether you earn 1.5% cash back on everything, 5% on specific things, airline miles or points. Since credit cards have such high interest rates, it doesn’t take long for 22% APR to eat up that 5% you earned on groceries.
Let’s say you have a credit card that offers 1.5% cash back on everything. You make a big $1,000 purchase for a new TV on that card. Great, you just earned $15 cash back. However, the card also has 19% APR.
The only way to avoid the offset is to use an account that started the billing cycle with a zero balance. If you pay off the $1,000 within that first billing cycle, you don’t incur any interest charges. But the instant you let the balance carry over to the next billing cycle, you just wasted that cash back you earned.
Introductory or promotional periods on new accounts are extremely beneficial. You can pay off your debt interest free for a period of time. This can be useful for big-ticket purchases like that TV from the example above. It can also help you to pay off debt quickly if you consolidate with a balance transfer credit card.
However, you need to be very aware of when your introductory periods end. At that point, interest charges will apply to whatever balance you have on the card. If you consolidated to pay off your debt fast, you want to finish before this period ends. Otherwise, you’re essentially right back in the situation you were before you transferred the balances.
Also be sure to check if the interest is simply set to zero during the introductory period or deferred. If interest is deferred then you absolutely can’t afford to let the balance carry over at the end of the promotion. With deferred interest, you must pay interest charges on the full balance even if you just have a small percentage of debt remaining.
Purchase acceleration is where you spend more on a credit card specifically for the purpose of earning rewards. It often drives people to go over budget and buy things they really don’t need. You make extra purchases at the airport to earn more miles. You charge incidentals to a credit card because you’re close to a certain point total. This is not a wise way to use credit, so recognize that it happens and avoid it.
If you miss a payment by more than 30 days, federal law requires the issuer to report it. They notify the credit bureaus and you get popped with a negative item on your credit report. This negative item remains on your report for seven years from the date the issuer reported it.
You get a new penalty at 60 days, 90 days and 120 days. Then the creditor writes off the account and moves it to charge-off status. This is typically when you encounter collectors.
If you miss a payment by a few days, you usually don’t have to worry about credit damage. It’s usually only when you’re late by 30 days or more.
Creditors don’t set minimum payment schedules to help you pay off debt effectively. In fact, it’s the exact opposite. Interest charges are how creditors earn revenue from you. So, it’s in their best interest to keep you in debt as long as possible. More months in debt means more opportunities for interest charges. That’s why they let you pay $20 on a $1,000 for 169 months. They end up making more money than what you initially charged.
Always try to set up your own repayment schedule to pay off outstanding balances faster.
Check the terms on your credit card agreement carefully to see how and when penalty APR may apply. Penalty APR is a higher rate that a creditor charges once you make a late payment. In some cases, it can be double your regulate rate. This quickly piles on interest charges on the debt you owe.
In normal circumstances, APR eats up about one half to two thirds your monthly payment. If you have 15% APR, it’s about half; at 20% APR it’s two thirds. So, if you double that rate you can get into a bad situation with negative amortization. This is where the minimum payment doesn’t cover the accrued interest charges on the account. As a result, you can make a payment and end up with a higher balance than when you started.
By law, a creditor must remove penalty APR if you make 6 consecutive payments on time. Then the creditor restores the original rate on the account.
Speaking of rates, it’s a good idea to check what’s happening with average credit card APR frequently. You want to know where average rates sit so you can negotiate effectively with your creditors. Negotiation is key, because your creditors will never volunteer to give you a better rate.
They increase your rates when the Fed raises their rate. They’ll give you a better credit limit so you can spend more money. But they won’t just offer you a lower rate, even if you have perfect credit. You have to call to ask.
One final trap to note is the idea that you have to pay what you owe using traditional means. It’s the idea that if you have $7,500 of debt to pay back at 23% APR that you’re stuck slogging through that with traditional payments.
It’s not true! As long as you pay back the principal– i.e. the original debt you incurred – it doesn’t cause credit damage. You can negotiate for lower APR, restructure your debt payments or consolidate. If the solution you use pays back the amount you borrowed, your credit shouldn’t be hurt. This is why a debt management program can help you build credit by paying off your debt. However, a debt settlement program hurts your credit because you only pay back a portion of what you owe.
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