Now more than ever, you need to have a credit card if you want to be able to make everyday purchases. From online purchases to vendors who have gone completely cashless, buying things with a credit card is now the mainstream way to pay.
Despite this trend, managing your credit properly comes with its own set of challenges. A few wrong moves, and you’ll end up owing thousands of dollars in interest and penalties plus taking a hit to your credit score.
That’s why if there’s one habit we can recommend that’s going to save you each time as well as avoiding all of this financial drama, it’s to make sure you pay your credit card off in full every single month. In this post, we’ll explain why that’s helpful and what you can do to put this into action.
You’ll Never Pay Any Interest
Plain and simple: If you want to never pay a penny of interest to the credit card companies, then you’ll have to make sure you always pay your balance in full.
Interest is the money that accumulates on top of the balance you owe after a certain period of time. Essentially, using a credit card is like getting a short-term loan. As you make your purchases, the credit card company is bundling them together into one bill that will come due on a preset date each month.
Once you receive your bill, you have what’s called a “grace period” of about 22 to 25 days to pay at least the predetermined minimum amount. Any portion that goes unpaid will become what’s called “revolving debt” because it will carry over into next month’s statement.
The troublesome thing is that once you’ve got revolving debt, that’s also when the interest will start to accumulate daily. Here’s how that works:
- Let’s say you’ve got a credit card with a 20 percent APR. If so, then the daily interest rate will be 0.000548 percent.
- If you’ve got a balance of $1,000, then you’ll be charged $0.55 on the first day bringing the total balance to $1,000.55.
- On the second day, you’ll be charged interest on the new balance of $1,000.55. The balance will now climb to $1,001.10
This cycle will continue and compound for every day that the debt goes unpaid. For many people, especially those who spend beyond their means, it can create a financial situation that spirals out of control.
Consider this example from Forbes:
- Let’s say you’ve got a credit card with a $5,313 balance and 16.28 percent APR.
- You decide to only pay the minimum payment of $110 per month.
- In that case, it would take you 78 months or 6.5 years to pay off both the entire balance (principal and interest).
- The total interest paid over this time would be $3,218
Do the smart thing: Save yourself from unnecessarily paying interest by paying your balance in full every single month during the grace period. An easy way to do this is to activate the auto-pay feature on your account. Set it to always pay the “statement in full” when your payment comes due.
Lowers Your Credit Utilization Ratio
At least 30 percent of your FICO score is made up of the amount of money you owe to your creditors relative to how much is available to you to spend. This is a figure called your “credit utilization ratio” and it’s recommended that you should not exceed 30 percent of your available credit. In other words, if you’ve got a $10,000 credit line, then you should never let your total balance run over $3,000.
Remember that your balance includes both the money you’ve spent this month as well as any revolving balances plus the interest you weren’t able to pay in prior months. That means if you’re in the habit of letting your balances carry over, then it won’t take long for your credit utilization ratio to grow beyond the recommended 30 percent threshold. And that’s going to be a problem for your credit score.
Do the smart thing: Use your credit cards conservatively to establish a good credit utilization ratio, keeping it to no more than 20 to 25 percent so that you’re well below the 30 percent danger zone. Pay off your balances in full so that you start with a clean slate each month and never give your balance a chance to balloon out of control.
Helps Establish Good Payment History
Another important factor of your FICO score is if you have a good track of making your payments. This counts for another 35 percent of the calculation.
Although all that’s required to be in good standing is to send in the minimum payment, remember that it’s not a good idea to pay only this amount. If you do, it will cause your account will accumulate interest as well as build up revolving debt.
Do the smart thing: Get in the habit of paying your credit cards in full every month and in advance of the due date. The byproduct of paying them off every time is that you’ll establish a rock-solid track record of responsible payments.
Practice Financial Responsibility
It’s all too easy to spend money when you’ve got a credit card. That’s why if you make a conscious decision to always pay your accounts in full, then it’s going to force you to live within your means.
Keeping your spending in check is not necessarily as easy as it sounds. The credit card companies are hoping that you’ll overspend and let some of your balance revolve. That’s when they can start charging you interest and making money off of you.
To avoid this, you’re going to want to start budgeting. Budgeting will give you a firm understanding of your monthly transactions. This will include all of your purchases as well as your income.
More importantly, budgeting can also help you to identify spending categories or areas of your finances that may potentially become issues. Once you know about them, you can start taking the necessary actions to get your money back on track.
Do the smart thing: Keep your money in check by establishing a budget. Plan ahead to always pay your credit card in full, and then monitor your finances to make sure that you’ll have the means to cover it. Practice this for long enough and it will become a natural part of your good financial skillset.
If you’d like some help creating a budget and keep track of your expenses, then put Buxfer to work. Buxfer’s Budget feature lets you connect to each of your financial institutions for continuous real-time monitoring. The app also lets you set spending alarms so that you’ll know when one or more categories have been exceeded for the month.
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