There’s a worrying trend emerging in Americans’ personal finances. Credit card debt and other revolving credit lines have been on the rise over the past few years and are now above $1 trillion.
Credit cards can be a great way to earn rewards when booking travel or to help small business owners cover an unexpected cost, but there are plenty of times when relying on them can be problematic.
Here are five times when using a credit card doesn’t make sense.
1. When you’ve got a large balance already
I remember using my credit card too much when I was in college and thinking, “I already have this debt; what’s a little more?” It wasn’t exactly a great debt reduction strategy, for a key reason.
Let’s say you have $2,000 in credit card debt and are paying the average 21% APR. If you pay $150 to the balance every month, you’ll pay it off in 16 months and spend $297 in interest. But if you add an extra $1,000 to the balance, it will take you nine months longer to pay it off and add $427 in interest payments.
2. Before you apply for a mortgage
When you’re applying for a mortgage, you want to be using as little of your available credit as possible. For example, if you have a $10,000 credit card limit, having a $1,000 balance is far preferable to a $5,000 balance.
Having a lower credit utilization shows lenders that you’re a responsible borrower. As an added bonus, it’s also good for your credit score.
In addition to credit cards, you should wait to open any new lines of credit, like a personal loan, until after you close on your home.
3. To get a cash advance
Cash advances are loans from your credit card issuer that quickly give you money you can use for a home repair, vacation, or anything else. That might sound enticing, but it comes with some very significant drawbacks.
First, you’ll likely have to pay a cash advance fee, which can cost between 3% to 5% of the loan. So, if you borrow $2,000, you’ll pay $80 if your fee is 4%.
Secondly, the APR for cash advances is even higher than for credit card purchases. For example, the average credit card APR is about 21% right now, but some card issuers charge nearly 30% for cash advances! At that interest rate, it would take 17 months to eliminate a $2,000 balance, and you’d pay $463 in interest by making monthly payments of $150.
Oh, and unlike other types of loans, there’s no grace period. Interest begins accruing the day you take a credit card cash advance.
4. You can barely afford the minimum payment
If you’re strapped for cash, making your minimum monthly credit card payment may be challenging. Unfortunately, needing a little extra money in your budget makes using your credit card all the more tempting.
If you need some extra cash, consider borrowing money from friends and family or taking out a loan from your 401(k). If those options aren’t available, consider a personal loan, which usually offers lower interest rates than credit cards.
Additionally, you may want to consider a 0% APR balance transfer card. These cards can help you pay off your balance by significantly reducing the amount you pay in interest each month.
5. You’re too focused on rewards
There are many great credit card rewards programs, including cash back and travel rewards. Many people use rewards to book free flights, get a free night in a hotel, or earn cash back on frequent trips to the grocery store.
However, focusing too much on rewards can be problematic if you open too many credit cards or rack up the balance just to earn the rewards. It’s a good idea to examine your credit card rewards each year to see if you’re actually getting value out of them.
While credit cards can be a good option in a financial pinch or to earn rewards, it’s best to evaluate how you use your credit card regularly. And if you need extra cash, it’s almost always a better idea to borrow money from someone or take out a personal loan, rather than use a cash advance from your card.
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