Credit cards are designed for convenience—a quality that is both an advantage and a threat to your finances. It's simple to pull out your credit card and pay for a dinner out, the new purse that you have been eyeing, or the video game that you have been dying to own.
Before you realize it, you owe hundreds of dollars on your credit card that you can't easily repay. In this regard, a credit card is akin to a trap that is set up before you to lure you into debt. If you want to learn how to avoid the debt trap of credit cards, you must fundamentally change your approach to using credit cards.
Create a Budget to Avoid the Debt Trap
Without imposing spending limits on yourself, you can buy indiscriminately and never know that there is a debt trap set up for you. In contrast, you're less likely to fall into the trap of excess credit card spending if you establish a budget: a plan for how you intend to spend your money every month.
To start, assess your income and expenses for one month. If you don't have a clear sense of what you spend in a month, track all of your expenditures over a month. Then, subtract your expenses from your income. If the number is less than zero, you are spending more than you earn and need to cut credit card spending or earn more to bring your cash flow into the positive.
If the number is already positive, as it should be, you are earning more than you spend. Implement a plan for how to spend the leftover money that month in a way that accounts for fixed expenses that stay the same each month, such as rent, variable expenses that change each month, such as utilities, and miscellaneous or one-off expenses, such as dining or entertainment. At the end of the month, evaluate whether you spent more or less than planned and update your budget for the new month accordingly.
Avoid Credit Cards Completely
If you are over-reliant on credit cards, identify the reasons why you need them. If your budget reveals that you're only overspending by a little, try switching a portion of your spending from credit cards to cash or debit cards to cover your expenses. The money you spend on a debit card gets withdrawn from a checking account, which allows you to avoid the debt trap.
If, however, you do not make enough to cover your bills each month by a wide margin, you may need to take the more drastic step of getting a second job or finding a new primary job that pays more.
Either way, until you secure the income needed to comfortably pay off the debt you incur from spending on credit, the only surefire way to avoid the credit card trap is simply not to use credit cards. If you don't have plastic in your pocket, you can't fall into the trap of overspending with credit cards.
Limit the Number of Cards You Have
The idea of shaving an extra few percentage points off of each purchase with a store credit card can be appealing, but it is a lot easier to fall into the trap of credit card debt if you are juggling multiple credit cards. It's also easier to miss a payment and to have a hard time making your payments on time each month if there are multiple cards the roster to keep tabs on. If you want the discount, consider a store debit card option that avails similar perks but avoids incurring a balance and thus avoids the debt trap.
To make this easier, avoid store credit cards completely and use just one or two major credit cards. This will help to limit any damage that you may do with store cards and may make it easier to take control of your spending situation.
While you may be tempted to close other credit cards as you pay them off, doing so reduce your available credit and lower the average age of your credit card accounts. Both of these changes can have the effect of lowering your credit card score. So if the card has no fee and has a low interest rate, it's useful to instead keep it open and exercise discipline in spending to maintain your credit score.
Do Not Carry Your Credit Cards on You
You may decide that you only want to use a credit card for emergencies or when traveling. If this is the case, don't carry the credit card with you. Take it with you on trips or when you think you may have a situation that calls for it. Otherwise, leave it at home in a safe deposit box or frozen into a block of ice—or contact the issuer and temporarily pause the card so that you can't put new spending on it.
You may also want to remove credit card information from the sites where you shop the most; having your credit card information stored is a trap because it bypasses the need to enter your card information, enabling you to go into debt in a single click. Any of these approaches can help you stop using a credit card for impulse purchases and ensure that you only spend on credit when the need arises.
Pay off the Balance in Full Each Month
If you use the credit card to earn reward points, and you want to use it for the rewards, pay off the balance in full each month within the grace period listed on your credit card statement. This is the number of days you have before finance charges kick in. Regardless of the annual percentage rate (APR) on the card, which is the cost of using the card, your credit card issuer won't charge you interest if you pay in full each month, so you'll avoid the credit card trap.
Subtract your purchases from your budget categories so that you can monitor the amount that you are spending each month and can stick to your budget. If you find that you cannot pay off the balance completely for one month, stop using the card until it is completely paid off. This allows you to take advantage of the rewards without paying any interest to the bank.
Remember: The reason credit card companies offer rewards is that they motivate you to spend. However, the bank gets more money since nearly half of customers do not pay off the balance each month. If you really want to be rewarded, avoid paying interest each month.
Keep Balances Low to Avoid the Trap of Credit Cards
If you can't pay off the balance in full, pay off as much as possible and keep the remaining balance low to avoid accumulating debt. Ideally, keep your total credit card debt as a percentage of your total available credit—known as your credit utilization ratio—under 30%. This means that you should maintain balances of no more than $3,000 if you have a cumulative balance of $10,000 in credit. Apply this same rule to individual card balances by avoiding a balance that exceeds 30% of the available credit on a card.
Of course, 30% percent is just a general rule of thumb; the closer you are to a zero balance, the less likely you are to fall into the credit card trap. People with the highest credit scores tend to have utilization ratios that are closer to 10%.
Set Up an Emergency Fund
Start by saving up between up to one month’s expenses; once you are out of debt, build an emergency fund, that will cover three to six months of living expenses. Once you have an emergency fund, you will be less likely to fall into the trap of using a credit card because you can tap the fund for emergencies such as car repairs or medical bills instead of whipping out that credit card.
Start by saving up between $1,000 to one month’s expenses; once you are out of debt, build an emergency fund that will cover three to six months of living expenses. It is a lot easier to make wise financial decisions and to work on paying off debt when you know you have the money set aside to cover sudden expenses.