When it comes to credit cards, there are two kinds of problems: little ones and big ones. I’m talking about the big stuff here. Getting a couple of bucks charged to your credit card in the form of a foreign transaction fee because you ordered shoes from a website that’s based overseas is annoying, for sure. But that’s not going to affect your cash flow for months, or worse, years.
On the other hand, there are some really, really bad credit card crises that can put a major dent in your finances. The good news, though, is that they are avoidable.
#1: Doing a balance transfer and then making purchases on the new card
This can be become a catastrophe of major proportions. Let’s say you transfer $7,000 of credit card debt from a card that charges 15 percent interest to a new card that has a zero percent interest intro rate for 12 months.
You notice that the go-to rate (the interest rate you’ll pay when the intro period ends) is 17 percent but you’re not worried because you’ll pay off the debt before the new rate hits. And then you plan to pay your balance off every month. Sweet deal, right?
But since this card also has a zero percent intro rate on purchases (plus rewards!) you can’t help yourself. So you start buying things with the intent of paying it off—along with your transferred balance—within the 12-month intro period.
Flash forward a year. You’ve now got $9,000 of debt and you have to pay this at a 17 percent APR. If it takes you three years to pay this off, you’ll pay $2,552 in interest costs.
How to Avoid it: If you’re susceptible to uncontrolled spending, you have to take that balance transfer card and put it in a bowl of water and freeze it. Or try this trick, which is my personal favorite from blogger Squawkfox: Put the card in peanut butter. That creates one really messy card that you won’t want to put in your wallet. You’ll also feel pretty silly trying to clean it.
#2: Buying something expensive and carrying the balance for a year (or more)
You knew this had to be on the list, right? Every credit card worth having has a grace period. This period typically ranges from 21 to 25 days. Pay off your debt before the grace period ends and you don’t have to pay interest. This is, in effect, an interest-free loan.
But this scenario happens all the time to people because they really believe they’ll pay off the debt when the bill is due. Here’s an example of how quickly “good intentions” lead to snow-balling debt.
Let’s say you need new carpet for your home and you find something you like for $3,000. You put it on your rewards card to get the airline miles, which, on average, would translate into $30 toward a plane ticket. You plan to pay it off before the grace period ends.
But your fridge breaks and you end up spending your cash on that. It takes you two years at 15 percent interest to pay off the carpet. You’ve spent a total of $492 in interest during this time. The total cost of your carpet? It cost $3,492 instead of the original $3000. All this for $30 in airfare savings.
How to Avoid it: I’m all for using cards to get the miles. But you need to have an emergency fund before you put a big-ticket item on a credit card. With a savings account, you have financial backup just in case things go terribly wrong in your financial life. Don’t set yourself up to have to pay off a major purchase at a high interest rate.
#3: Getting a large cash advance on your credit card
This simple act gets a lot of people in trouble. Here’s a common scenario that sets up this particular catastrophe: You’re maxed out on your credit cards except for one. To pay your other cards, you get a $1,200 cash advance from the card that isn’t maxed out yet.
The variable APR on cash advances averages around 22 to 25 percent (some less, some higher). The interest clock on cash advances starts ticking the second the cash slides into your hands. If it takes you a year to get out of this mess and the APR is 25 percent, you’ll pay $169 in interest. So the $1,200 cash advance has cost you $1,369.
This can happen on a small scale, too. You’re out and you need cash. You withdraw $100 here and there. It all adds up and it’s a terrible waste of money.
How to Avoid it: Okay, first look at the reason why you’re doing this. If it’s like the scenario I outlined above and you’re desperate for cash, contact the National Foundation for Credit Counseling and ask for help. Don’t continue down the road of getting cash advances to cover your bills from one week to the next. You’ll end up in a very bad place financially. Much worse than the one you’re already in.
If it’s just a lack of knowledge about the interest expense, well, now you know. Only a life-and-death situation should force you to get cash at a 25 percent APR.
#4: Carrying a balance and then being over 60 days late with your payment
If your payment is more than 60 days late, your credit card issuer can apply the penalty rate to your entire outstanding balance. That $5,000 balance you have at 12.99 percent? Now, your rate is 29.99 percent and it’s applied to the whole $5,000 from this point forward.
To be clear, the outstanding balance is defined as the balance on your card 14 days after the notification is mailed. And the penalty rate takes effect 14 days after the postmark date.
If it takes you two years to pay the $5,000 off, you would’ve paid $705 in interest expense at the lower 12.99 percent rate. But now you’ll pay $1,709 in interest because you’re paying at the 29.99 percent penalty rate. You’re paying over $1,000 more. And this is if you don’t spend another dime on that card.
How to avoid it: Obviously, don’t be late! From a practical standpoint, ask yourself how this happened and solve it from there. Did it fall through the cracks? If so, you need a system of reminders so this never happens to you again.
Consider using email alerts, such as those you get from Mint or from your bank. I use alerts from both. I also have important due dates flagged in my monthly calendar in Outlook. If one system fails, I have others for backup. I probably sound a bit neurotic, but I’m a time person. I don’t like to be late for anything. When I travel, I not only ask for a wake-up call, I also set my phone. What can I say? I’m rarely late!
If you’re having trouble with cash flow and can’t pay, call your issuer and see if they can work out a delayed payment date (or something similar) for you. Don’t wait until you’re stuck with a penalty rate. Be proactive and you might avoid this scenario.
#5: After receiving notification that your interest rate is increasing in 45 days, you go on a spending binge
All the “talking points” about the Credit CARD Act of 2009 led many to believe that they had a full 45 days before a rate increase took effect. So many consumers assume that if there’s something big that they need, they can buy it before the 45-day mark hits and pay it off at the old rate.
Here’s the deal: If you receive notice of an interest rate increase on your credit card, your new rate is applied 14 days after the postmark date—not the 45 days that’s implied under the CARD Act. You actually start paying the new rate after 45 days, but the higher rate applies to any new purchases you make after the 14th day. So that new lawn mower you thought you bought at a 10 percent rate is actually accruing interest at 14 percent.
How to avoid it: Knowledge is power so now you know the scoop. If you’re carrying a balance, don’t make it worse. In fact, get on the phone and see if you can talk your credit card issuer into giving you a pass on the new rate. Or at least see if you can negotiate the new rate down a few percentage points.