Are you one of them?
According to a recent study conducted by Bank Rate, 67% of Americans carrying debt balances on their credit cards are still spending with them in hope of earning rewards.
Bad idea!
Money expert Clark Howard says the end result of this strategy can be catastrophic for your personal finances.
"Even if you have a credit card that is giving you cash back, points, miles, hotel stays or whatever the ratio is for whatever the prize is at the end of the day — That is fool's gold because of what you're paying in interest," Clark explains.
Let’s walk through why Clark has such a big problem with carrying debt on rewards credit cards and talk about some potential alternatives that will put money back into your wallet.
Why This Credit Card Strategy Is Troubling
On the surface, rewards credit card seem great.
They can be a great way to earn travel rewards or cash back on everyday purchases. In fact, Clark carries several, such as the Capital One Venture X Rewards Card and Citi Double Cash® Card, in his wallet.
But the key to using these cards successfully is paying the balance in full each and every month.
Even an occasional slip up on this can flip the script and make rewards credit cards a losing proposition.
“It’s not at all unusual for a rewards card to have an interest rate of 25%,” Clark says. “You may be getting a 2% reward on your spending, but you’re not going anywhere. You’re going backwards!”
To put that into some real-world terms, consider this example:
- Let's assume you have a rewards credit card that pays you 2% back on every purchase you make, but carries a 25% APR on balances that aren't paid in full.
- Let's also assume that you made a $1,000 purchase with that card that you couldn't afford to pay off right away.
That purchase would earn you $20 in cash back rewards right away.
But even if you had an aggressive game plan to pay the debt back in three months with $350 installments would cost you approximately $21 in interest. And it only gets worse from there.
I used Discover's credit card payoff calculator to illustrate how quickly you could owe way more in interest than the $20 you earned in cash back rewards:
What Credit Card Debt Carriers Should Do Instead
Team Clark often suggests using rewards credit cards in our credit card content. But we do so with the caveat that you must pay the balance in full each month to gain any benefit from those credit cards.
If you’re one of the people who has been using a rewards credit card to spend more than you can pay off each month, you have some action to take in an effort to “right the ship” financially.
1. Stop Using Your Rewards Credit Card and Attack the Accrued Debt
If you’re finding yourself unable to meet the full balance obligations on your spending each month, we suggest that you consider moving away from spending with a credit card altogether and work to pay those balances off as soon as possible.
Being proactive in this measure could save you hundreds, if not thousands, of dollars in interest accrued in the months ahead.
Attacking debt can seem overwhelming, but we have some resources to help!
Team Clark has a strategy for eliminating your credit card debt within three years. And you can use a credit card debt payoff calculator to help get a personalized payoff plan started. If you're having trouble, you can always reach out to Team Clark's Consumer Action Center for free assistance.
Though the consumer protections offered are not as good, you may find that using a debit card (or paying with cash when possible) is the best strategy for making necessary purchases while trying to rid yourself of credit card debt.
2. Consider Applying for a Different Credit Card
Avoiding carrying balances is always preferred, but not always possible.
If your financial situation makes carrying a credit card balance an unfortunate necessity from time-to-time, you need a plan for mitigating the damage.
The best preemptive measure you can take is to ensure the interest rate you’re paying on your balance is as low as possible.
We know that rewards credit cards are particularly bad for this because of the high APR charged on balances for these cards, so using those should be avoided whenever possible.
Clark says that you can shop for a new credit card from a local credit union to help.
“I want you to shop for a new credit card,” Clark says. “And the best place to start and probably finish the search is with a credit union that you may drive by every day and not even notice.”
The business model of credit unions, which are owned by their members, is to provide services for the membership at the lowest possible costs.
With this goal in mind, you’ll generally see much better terms on a credit card than a for-profit bank is able to offer.
The interest rate on a credit union credit card can be less than half of what you might see on your big-bank rewards credit card.
These credit union cards may not offer much in the way of rewards on spending, but the 10-15% of APR you may save on interest for your balance is going to make a much bigger impact on your wallet than the 2-5% you could earn with a big-bank rewards credit cards.
Do you have some tips to help others avoid this mistake? We’d love to hear how you’re managing your credit cards in the Clark.com community.
The post Clark Says This Credit Card Mistake Is Like Chasing 'Fool's Gold' appeared first on Clark Howard.