Debt and Credit Cards.
Those four words have received quite the reputation over the years. Credit cards can be a very difficult tool to manage, yet a useful and reliable tool, should you use them correctly. What is the correct way to use them, you ask? Honestly, I do not have a direct answer for that. I do, however, have an answer for the way we use them and how they work well for us. I’m here to share that with you, today, and talk about ways you may need to reevaluate your thoughts on debt.
The debt mindset
First of all, let’s talk about debt. I discussed debt a little bit in THIS post and would really encourage you to take a moment to read through that post as well. Debt can be a scary thing, should you be careless about it. At the same time, I want to challenge you to think about debt in two different ways. Good debt and bad debt.
What’s the difference, you ask? Debt is debt, right? No, not exactly.
Good debt is something that can help to better your credit score, and keep you on track for your financial goals. Certain kinds of good debts can also give you equity, should you need to revaluate your purchases. There are certain things in life that we need, which we just cannot achieve without going into debt at some point (some of these are discussed below). However, the ultimate goal is to steer away from the good debt as quickly as possible, freeing you up financially.
Bad debt is something that causes you to get stuck in a particular financial situation, or has negative effects on your financial goals. Sometimes bad debt is unavoidable, but if you follow the ideas in my budgeting practices post HERE, you’ll be able to pull out of that bad debt quickly, and be able to manage those situations more responsibly when you want to make a purchase that could result in bad debt.
What are some examples of good debt and bad debt?
GOOD DEBT:
- Mortgages
- Vehicles
- Credit cards (hold up, I’ll explain more on this soon)
Mortgages and vehicles can be a good purchase for you to have, as they can give you equity, should you need to sell.
While recreational vehicles and trailers can give you equity, we don’t necessarily consider those things GOOD DEBT, as they are more of a luxury than a necessity.
Credit cards are a different story because they do not necessarily offer equity either. I’ll address the details of this soon to clarify how these can be a good debt. Stay with me.
BAD DEBT:
- Rent
- High rate interest loans
- Credit cards (yes, they made it to both lists)
I look at rent as a bad debt in that it is a payment you are making without progressing you toward a long-term financial goal. You do not get equity from rent, as you would a mortgage, and it really has no impact on your credit scores. Rent-to-own options are a bit of an exception to the case, as that turns over more to the “mortgage” category. However, those options are few and far between in our day and age.
High rate interest loans are something you need to avoid AS MUCH AS POSSIBLE! Is there really anything out there that you need THAT badly to need to pay such an outrageous amount over time? If so, that item would then need to fall to the top of your priority list of items to pay off ASAP with your debt payoff ratio listed HERE.
Credit cards have been widely abused by many over the years and are the main source of mountains of debt. Most people use credit cards as their “emergency plan”, or use them to make a purchase when funds are a little lower than needed for a particular item. Just like high rate interest loans, credit cards have interest rates that are not easy to tackle when the balances are outside of your income ratios.
Tackling and evaluating your debt
So, now that we’ve talked a little bit about good debt and bad debt, I’d like to challenge you to write out how much of each of those you have at this moment. Are your bad debts overpowering your income ratio? How long is it taking you to pay off some of the bad debts and how long have you had them? Are you noticing any of those bad debts continuing to grow, rather than getting lower?
If you are relating to any of these question, you need to set up a debt payoff plan and implement that plan NOW, based on my 20% flex plan HERE.
Using credit cards with debt
This topic can be a little controversial. Some financial advisors will tell you to cut up your credit cards. We do not agree with that. You have every right to make your own informed decision on whether or not you agree with me. I’m going to explain how we use credit cards, what we have learned over the years, and why I encourage you to seriously evaluate your relationship with credit cards.
As I have previously mentioned, I believe that credit cards can fall into the topic of both good debts and bad debts. However, it is nearly impossible for them to exist hand-in-hand, simultaneously. You need to identify how you currently use credit cards and decide now if you need to make a change.
In our early years of marriage, we would fall to the use of credit cards as a crutch. Now, we never got into mountains of debt that we could not control, but it was definitely more than we were comfortable with at times. Being young and naïve, it was easy to want things we did not have the ability to pay for with what money we did have. Well, why not put that on a card and just pay for it a little over time, right? Unfortunately, because of interest rates, we ended up paying more for that item, over time, than we would have paid should we just had a little more patience with ourselves until we did have the money in-hand.
How often has this happened to you? How many times have you used a holiday bonus or tax return to pay off a pressing debt, rather than investing it or enjoying that amount for something more for yourself? For us, our reality about this hit years ago when we took a good, hard look at our spending habits and finance management. Once we accepted the fact that these habits were not in line with our long-term goals, we decided to make a change and addressed those habits with my 20% flex plan, putting the debts at a high priority in our flex ratio. It did take a little bit of time and patience, but we were eventually able to correct our habits and use our credit cards as good debt.
The way we now use our credit cards is NOT something I suggest until you have a good idea of your income and expenses, as well as ensuring you can manage those well for an extended amount of time. If not managed correctly, this process could actually put you back into bad debt and restarting your process all over again.
Alright, with all honesty, here its. We use our credit card as a debit card.
Now, hold your gasps and reprimands until you more fully understand the details.
As I have explained in THIS post, we manage our finances on a VERY regular basis. Twice a month, at minimum. In the beginning, after we fully understood our boundaries for our 70% spending allotment, we decided to give it a try for two weeks, using only credit cards for purchases (gasp, I know). During this time, we were very conscious of our spending and did our best to not go out and make unplanned purchases or excessive spending. At the end of the two weeks, we sat down during our budget date to evaluate EACH AND EVERY charge, adding them up into our 5 different spending categories, and cross-checking that those amounts still fell into our 70% spending allotment. Surprisingly, we were well under. Though, if I really think about it, it may not be so surprising knowing we were just hyper-aware of expenses during that time. We would then immediately pull the totals out of our checking account and pay off that card, with that allotment. Similar to a debit system, we just had a better eye on where the money was going.
The MOST IMPORTANT thing to remember in using this practice is that you absolutely have to be disciplined to regularly evaluate your spending and pay those charges off immediately. Should you let them lapse for even a day too long, interest rates will take over and you will start to accumulate bad debt. Remember, most cards have a 30-day interest charge period. Some cards can be different, so you will need to check with your financial institution to verify how this applies to you. Even if you have the 30-days, PAY IT OFF BEFORE THEN!! There is no reason to push things that closely.
After we saw how this worked, we tried this practice again and again, until we agreed that we were comfortable with our spending habits and very aware of the amounts we had available for that spending. Because were were having a regular check-in with our budget dates, we were being held accountable with each other.
Now, you may be asking WHY? Why go through the extra steps of using a credit card vs a debit system directly through a checking account? For us, there are two main reasons.
- Maintaining and continuing to build our credit score for which we have worked so since the beginning of our marriage.
- Utilizing a rewards system through our credit card company.
You may fully agree with the first and recognize the benefits of this.
The later can be a controversial topic and you have every right to your opinion. If you are unaware of the rewards systems available, I ask you to talk to your financial institution or credit card company. There are so many options out there, you need to decide what is best for you. The card we use allows for airline credits, cruise credits, gift cards, etc. We feel that it fits well into our interests. Things may be different for you.
** I will go more into credit card rewards and how we use them to contribute to our family vacations. Stay tuned!
Managing your debts YOUR way
As you will likely agree, I can give you all of the tips I have, but managing debt ultimately comes down to discipline and finding a solution that works well for you. We have tried a few different approaches to debt management and this option I have shared works best for us. I would like to invite you to implement some practices that relate most to you. Remember, start with some small baby steps and take things one bite at a time. Long-term changes don’t happen overnight.
As always, I’d love to hear from you and learn of ways you find success with your budgeting and debt management. Feel free to leave a comment on this post with your thoughts and ideas!
Want to learn more? Don’t miss my other post in this series:
Budgets and Sacrifices – a financial management program that works for us NOW!
Tackling Debt – credit card use WHILE managing your debts!