Editorial Policy

Credit Cards are Not Budget-Buffers

Eva Norlyk Smith Ph.D.

June 4, 2013

QHi Eva,

I am 28 years old, and I have only had one credit card my whole life. I got a Bank of America credit card when I was about 22, and I maxed it out (the limit was $1,000) and never paid it off. I don't remember details for that card as far as APR and such. I'm not very savvy in that department at all, and I want to become more educated on building credit and using credit cards to my benefit. I don't even know where to begin to make any kind of payment on that card, and surely by now it's been sold to a debt collector.

My credit is not bad, but it isn't great either. Can you point me in the right direction with what would be the best type of card for me?  I see the benefits of having a credit card. I could buy diapers, groceries and gas and pay it off over time if I'm short on money in a particular month. But I have no idea where to start and I'm desperate for some expert advice. Can you please help me? — Brandi

ADear Brandi,

Wow, that's a mouthful. First off, give yourself a pat on the back for deciding to learn more about building credit and using credit cards wisely. Having an excellent credit score will give you access to many financial benefits throughout your life.

However, take note: Before you venture into building credit, you have to first develop good financial management skills. Otherwise, you will probably make the same mistakes you made six years ago — and end up with even more than $1,000 in credit card debt.Ask Eva

Why do I say this? Because you're still making a troublesome, but all too common, mistake: You are assuming that credit cards are a way to stretch your cash so you have money left over at the end of the month. They are not. So, before you venture into improving your credit, learn these three lessons:

Lesson No. 1: Credit cards are for convenience and credit building, not for cash.
The worst thing you can do is to use your credit card for everyday expenses to make your paycheck last a little longer. Credit cards just don't go well with diapers, groceries and gas (unless you have a rewards card and excellent financial discipline). These are everyday expenses, and the moment you start taking on debt to pay for them, you begin digging yourself into a financial trap that can take years to escape.

Lesson No. 2: Paying debt off slowly is expensive.
It seems like a great bargain: You charge your monthly expenses to your credit card, and at the end of the month, all you have to pay is the $30 or $60 minimum monthly payment.

Watch out.

Paying the minimum month after month is something you can't afford to do. To see why, you have to understand the power of cumulative interest charges. Credit cards for people with bad credit come with high annual percentage rates (APRs) — you can expect to pay 20 percent or higher. This means that, for every $100 you carry on your credit card, you'll pay at least $20 a year.

Want to guess what it would cost you to pay off $1,000 (the amount you already owe), if you were to pay just the minimum each month?  I've done the math for you. Assuming the minimum monthly payment is 1 percent of the balance plus interest charges (which is typical for most issuers), and the APR is at 22.99 percent, it would take you 123 months (that's 10 years) to pay off the $1,000. And over that decade, you'd pay $1,262 in interest charges — more than you originally borrowed.

How can this be? With a 22.99 percent APR, the minimum monthly payment isn't that much higher than the interest charges. That means a big chunk of the payment you send would go toward interest charges instead of toward the principal. Your debt shrinks slowly, leaving plenty of time for the bank to tack on more interest charges.

Lesson No. 3: You need to fix your credit before seeking more.
Given the default in your past, it probably won't be easy for you to get another credit card. So for now, consider getting a card designed for people with bad credit. Just know that you'll have to pay more for one. A secured credit card, for example, would extend you a small line of credit in exchange for a deposit. That won't help you much with your plans to stretch your paycheck. But the idea is to build a better credit score — and that means paying your dues by making small, controlled charges each month and paying them off on time until an issuer is willing to offer you a better card.

You might also consider calling in a professional to help you deal with your 6-year-old debt. A nonprofit credit counseling agency should be able to help you with your existing debt and guide you in building a healthier credit future. In the process of learning how to build a good credit score, you will also learn how to take better control of your finances — and find other ways to have money left over at the end of the month besides charging those diapers to your credit card.

Got a question for Eva? Send her an email.