Nothing boosts your spending power faster than having a few credit cards. It’s a matter of simple arithmetic – each credit card you possess right now has a credit limit that’s easily 3X to 4X your monthly income. And then there are credit cards like the American Express Platinum Credit Card that have no established spending limit.
That’s a pretty scary realisation – to know that you have all of that “borrowed” financial power in your wallet. But what’s even scarier is what can happen if you misuse your credit cards and end up in debt.
But you can avoid that endless debt cycle. You just need to be aware of these dangerous mistakes that may land you in the financial black hole known as credit card debt:
Believing That Your Credit = Your Money
There are plenty of great reasons why you should have credit cards. When used wisely, credit cards can have a positive effect on your financial situation. They can provide you with money saving discounts, rebates and rewards.
More importantly, using your credit cards right will improve your credit score, which can result in easier approval and better interest rates when it comes to borrowing. But too many people make the dangerously simple error of believing that credit is an extension of their income.
Yes, your credit cards give you the ability to spend up to 4X your monthly income, but it’s not your money. It’s the bank’s money, and it comes with a pretty hefty interest rate of 24% or higher on any rollover balances you carry. And if you let that rollover balance accumulate each month, it’ll rise faster than the PSI level during burning season.
So, before you reach for your purse or wallet to make a big purchase, think about whether you have enough of your own cash to make the purchase (or at the least, set aside the cash from your next pay cheque to pay off your balance in full).
Making Big Purchases with Credit
The greatest benefit of having a credit card is also its greatest danger – the ability to swipe your card and make a purchase in seconds. If you’ve seen our infographic on the anatomy of a credit card transaction, you’d see your 10-second purchase is way more complex that you realise.
Seriously, it’s just as easy for you to walk into a convenience store to buy a S$1 bottle of water as it is to walk into a watch store and buy a S$10,000 Rolex. And that’s the problem. All it takes is a 10-second purchase to rack up a huge balance that leaves you saddled with a credit card debt at 24%+ interest rate.
Yes, you should certainly avoid buying a S$10,000 Rolex if you can’t pay off your balance in full. But there are other purchases that are not as straightforward:
- Expensive holidays
- Major down payments, such as a car loan
- Hefty medical bills
- Tuition fees
Remember, that 24%+ interest rate can snowball your debt into an insurmountable amount before you can say “credit card”. So, if you really need to make a big purchase, another option you can consider is personal loan, with a much lower interest rate ranging from 7% to 11%.
Utilising Too Much of Your Available Credit
It doesn’t matter whether you end up using too much of your credit because you are unsure of your credit limit or you couldn’t resist making a big purchase – the end result is always a high credit utilisation ratio.
Your credit utilisation ratio simply shows how much of your credit balance is being used. For example, if you have a credit limit of S$10,000 and you have used up S$9,000, your credit utilisation is 90%.
The danger of having a high credit utilisation ratio is twofold – first, you’re going to inevitably end up with a high amount of credit card debt and second, the higher your ratio is, the worse your credit rating becomes. And when your credit rating becomes bad, lenders end up raising your interest rates whenever you want to take out a loan, or they simply won’t lend to you.
If you want to stay in the credit bureau’s good graces, make sure you maintain a credit utilisation ratio of at least below 30%.
A credit card is just like a knife — it can be an useful tool if used correctly, but if not, it can cut you badly. Every purchases you made must be made with forethought and careful consideration, even if you are using a credit card to pay for it.
Want the best financial deals in town delivered to your inbox once a month? Sign up for iMoney’s Monthly Round-Up today!