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?
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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.
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#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.
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Image: mlinksva, via Flickr.com