Credit is power. Given the convenience of credit cards, you might feel tempted to abuse the spending power that credit cards give. When your credit limit is 3 to 4 times your monthly income, it can make you feel richer than you really are.
It’s a dangerous illusion. While there are attractive rebates, rewards and air miles to collect when you use a credit card, and sometimes you even get vouchers for just applying, credit card debt is one of the most costly debts to bear.
The key to have credit cards then is to develop good habits and avoid these 3 fatal credit card mistakes:
1. Thinking that credit is “your” money
Whenever you reach into your wallet or purse to pay for something, what do you reach for first to pay for it? Is it your credit card? Is it always your credit card?
There is nothing wrong with that per se, but don’t feel comforted by simply staying within credit limit, because credit is not your money.
Instead, strive to keep the money that’s spent on these credit cards within a set budget that you have decided on. To keep things simple, limit your usage to only one card so it is easier to keep track of your total credit card expenditure.
Remind yourself to pay off your bill fully every month, as the money owed will incur a tremendous interest rate of ~24%, and your debt will snowball so quickly you will find yourself in deep trouble just after a few months.
2. Financing extremely big purchases with credit so you can pay later
It’s pretty easy to spend with a credit card as all you have to do is swipe and go. The mere promise of getting to pay later prompts people to swipe impulsively, sometimes purchasing hundreds of dollars’ worth of merchandise within minutes.
If you want to swipe big purchases, we would advise making it a habit to check your bank balances to ensure that you actually have enough. And if you tend to forget tracking your finances, it’s good to pay your bills in advance.
Whether is it an expensive holiday, recurring tuition fees or major downpayments (e.g. for a new car), either make sure you have that amount in your bank first, or don’t do it.
3. Having a high credit utilisation ratio
If you make credit mistakes #1 and #2, you’re bound to end up with a high credit utilisation ratio. What is your credit utilisation ratio? Simple, it’s the ratio of your credit card balances to your credit card limits.
For example, if your credit card has a credit limit of $20,000 and you use $15,000 of it to purchase an Hermes bag, your credit utilisation ratio would be 75% ($15,000 credit card balance / $20,000 credit card limit).
This is important because the higher your credit utilisation ratio is, the more you’ll scare the credit bureau into lowering your credit rating. That will in turn affect your ability to borrow for really important things like a house.
The only way to get your credit score back up is to reduce your balance to a reasonable credit utilisation ratio of at least below 30%.
What are some other credit card mistakes people should know about? Share with us below!