[ Finance ]

Credit Card Debt, A Barrier to Financial Freedom

When we decided to travel full-time for two years (at least), our preparation list was long and full of questions. What do we bring? Where do we go? How long do we stay in each place? This is just the beginning, but one factor stood out among all the rest. How do we pay for things with no jobs? Financial proficiency was a necessity for us when we considered this lifestyle, but it is important in any phase of life and no matter what you plan to do in your future. Being smart with your money opens up possibilities you may have previously thought were fantasy, and it all starts with some basic concepts. These tenets may be easy to some and seemingly impossible to others, but they are all simple concepts to grasp even if they are difficult to implement. Perhaps the simplest and most effective habit that helps you accomplish your financial goals is to be free of credit card debt.

Our hope is you can scoff at this statement as if it is ludicrous to even hint that you have credit card debt. If that’s the case, we salute you and give you a high five! But the truth is that more than a third of American households have credit card debt and the average balance is over $16,000 for those that don’t pay it off every month (as of May 2016). This is far too great a number! You may be thinking that having this debt is fine and it’s just part of life. If so, we hope you challenge that way of thinking because it is costing you dearly. It’s not fine and it doesn’t need to be part of life!

Now, before we begin, we don’t want you to think we are part of the seemingly large group of people who teach the idea that credit cards are inherently bad. Credit cards have some excellent benefits, but only if you use them responsibly. It’s like riding a bike. The action itself isn’t bad. But if you barrel down a mountain single track without wearing a helmet you are asking for trouble. The responsible use of credit cards, which means paying off your complete balance at least every month, is good. The irresponsible use of credit cards, which means carrying a balance and paying anything less than your total bill at least every month, is bad.

The financial reasons alone will prove that carrying credit card debt is a horrible idea and we will cover that in a future post. But first, let’s just take a look at the logical side of it all.

Logical Crash Course in How Credit Cards Work

Credit is the idea that you will get something now from a person/entity with the agreement you will pay that person/entity back in the future, and at times with interest. Generations ago, this would be like having a tab at the general store that you would pay every week or so. The shop owner didn’t expect money at the time of purchase, but they absolutely expected you to pay for your items.

Credit cards work in a similar fashion. When you buy something with your credit card, the bank actually pays the store for your items. At the time of purchase you see no money leave any of your accounts, only a balance on your credit card because you have agreed to pay the bank back for footing your bill. This goes smoothly if you actually pay the bank back when you are supposed to. It goes badly if you don’t.

This is different from a debit card, which is linked to your checking account at a bank. When you buy something at a store with your debit card, the money is automatically taken out of your account. If there is no money in your account, you aren’t buying anything!

With a credit card you can spend up to a certain limit set by your bank, regardless if you actually have that much money. This limit is called your credit limit and is basically how much debt the bank thinks you can have and still be able to pay them back. It should not be treated as the amount of “free money” you have received from the bank because you haven’t received anything! A credit limit is not a loan. It should also not be spent just because the bank will allow you to. Does it make sense to spend $4,000 in one month since that is your credit limit if you only make $1,500 in one month? No! So don’t do it!

Basic Example, Logical Version

  1. Jim spends $100 with his credit card at the grocery on May 1st.
  2. Jim’s bank pays the grocery store the $100 on May 1st. Jim doesn’t see $100 leave his bank account because he used a credit card and that’s not how they work (see above). Jim does see $100 added to his credit card balance.
  3. Jim buys nothing else with his credit card.
  4. Jim receives a statement (bill) from the bank on May 15th saying he owes them $100 (from his grocery purchase on May 1st) which he needs to pay before June 1st.
  5. Jim pays the bank $100 before June 1st because, after all, he did spend $100.
  6. The bank got their money back on time so Jim owes the bank nothing more than the $100 he spent on groceries.
  7. Jim is fed, debt free, and happy.

But wait a minute…what is this minimum payment thing on his bank statement? The bank says he only needs to pay $25. Man, what a deal! Jim spent $100 but only has to pay the bank $25! These credit cards are awesome and it’s no wonder people get such awesome stuff with them all the time! It’s like free money!

What, no! Don’t get distracted! Flashy objects sure do grab our attention, but don’t be blinded by them! In what world does it make sense that if someone foots your bill for $100, they only expect $25 in return? Banks are in the business of making money, and they are good at it. They present that shiny object (the minimum payment due) so you get distracted and disregard logic. When you do only pay the minimum payment they charge interest, which is when they make the most money.

credit card minimum payment due
The bank only wants $30 when I owe them more than $3,000! That makes no sense.

But anyway, let’s take a look at what happens when Jim gets distracted by the bank’s shiny object.

Basic Example, Illogical Version

  1. Jim spends $100 with his credit card at the grocery on May 1st.
  2. Jim’s bank pays the grocery store the $100 on May 1st. Jim doesn’t see $100 leave his bank account because he used a credit card and that’s not how they work (see above). Jim does see $100 added to his credit card account.
  3. Jim buys nothing else with his credit card.
  4. Jim receives a statement (bill) from the bank on May 15th saying he owes them $100 (from his grocery purchase on May 1st) which he needs to pay before June 1st.
  5. Jim notices his minimum payment is only $25. Score!
  6. Jim thinks the bank is his new best friend because they “gave him $75 for free.”
  7. Jim only pays the bank $25 before June 1st, even though he actually owes them $100, because the bank told him that’s all he had to pay. His real friends become concerned because that makes no sense.
  8. The bank high fives itself and throws glitter everywhere to hopefully trick other people into giving them money when they don’t have to.
  9. Jim invites the bank to parties and keeps giving them extra money for years while he goes hungry because he can no longer afford more groceries.
  10. You, the reader, realize this scenario is ridiculous, and wish Jim would have just paid the bank what he owed them by his due date. It would have saved us this nonsense!

Ok, Ok, So Now What?

It is illogical to carry a credit card balance. But what do we do about it if we have some from before reading this? Pay it off as quickly as possible! Every dollar you spend should be weighed against paying off your debt. How much do you want whatever you’re about to buy? It doesn’t matter if it’s a fast food meal, or happy hour drink, or a new pair of shoes, or even a grocery store bought treat. Do you want it more than a credit card debt free life? You should weigh all of your spending against what you owe because whatever you spend could be used to lower your debt to the bank. Your first financial priority should be paying off this debt. Don’t be one of the people that make excuses or say they will “get to it.” That attitude will get you absolutely nowhere.

Whenever it seems hard, just imagine life without constant bills or always owing someone money. Sounds pretty nice, doesn’t it? Remember how nice that sounds whenever it doesn’t seem worth it to pay off your credit card debt as quickly as possible. You are making the hard decisions now in order to live the life you want later. Trust us, it’s worth it!

If you do have some credit card debt you should calculate what you will end up paying the bank for what you owe. You can do that thanks to some helpful calculators online. Several exist and you can do a search for your favorite, or you could click here and be taken to one right away since you’re eager to get going on paying off your debt!

You Also Should Know…

If you don’t pay off your full balance by the date it is due, the bank begins to charge you interest on your purchases. Credit card interest rates are generally high with the average being more than 13%. This means you end up paying a lot more than what you actually spent. (If you do only pay your minimum payment you avoid late fees, so you still should absolutely pay your minimums at the very least. But this should be avoided if you know you can’t pay your full balance in time by not buying whatever you are thinking of buying when you can’t afford it!)

A good thing is that in 2009 Congress passed a law that in part requires banks to be more open about what happens when you only pay the minimum payment. Now you get a minimum payment warning on your statements. This warning tells you what you end up paying if you only pay the minimum amount due. Occasionally it offers a “cost savings” tip if you were to pay more than the minimum amount due but less than the total balance. Remember, if you pay anything less than the total balance, you will pay interest.

credit card minimum payment warning
A $3,084.43 bill turns into more than $6,000 if you take 14 years to pay it off with only the minimum payment. The “cost savings” option is $2,499 less, but still significantly more than the bill and takes three years to pay off! This is the warning from the same credit card statement as above.

This “cost savings” tip is compared to only paying the minimum payment due. However, we know the minimum payment due is only a way to make us pay more. This “tip” is designed to get you to pay interest masked as a way for you to save money. They aren’t lying to you, but you will still pay more than your original balance. What they should actually say is how much more you end up paying with only the minimum payment due, or even by using their “cost savings” tip, when compared to paying your full balance. This would definitely be clearer to you, the customer. But that’s OK, because here at The Cheers Life and your household, we read things, think, and make conscious decisions instead of going through life in hopes that everyone will just look out for our best interests.

You may be wondering why we are focusing on credit card debt. It is important to pay off all of your debt and meet any monthly minimum payments (on things like student loans, auto loans, etc.). Credit card debt normally carries the highest interest rates, by far. When paying off debt, always pay off the highest interest rate first, which is why credit card debt should be the first to go.

Payday loan interest rates are even higher, and for goodness sake, as bad as credit card debt is, payday loans should be treated like a plague. Like that song from, “How The Grinch Stole Christmas,” about how you shouldn’t even touch it with a 29 ½ foot pole. And that’s putting it lightly!

Once You Pay Off Your Credit Card Debt

CONGRATULATIONS! You accomplished something far too many only dream of doing. More than just dreaming about it, you did it! Sure, plenty of times you doubted why you were doing it. Maybe your friends urged you to “live a little” and not worry so much about it. But you are living a debt free life!

Now you know you can do anything. You’re empowered. You’re happy. You’re motivated. You are in control of your money, not the other way around. You know the importance of paying off your debt. How good does it feel to not owe anyone money?! Most importantly, you’re going to hold on to this freedom and remain debt free.

Now that you have crossed that line, what do you want to accomplish? The answers to that are limitless, but let’s see where they take us!

© Cheers Life Partners 2017

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The Cheers Life

We make every day worthy of a toast! We quit our jobs in October 2016 to travel the world full time.

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