Are you one of those people who has a credit card, but don’t necessarily need it?
In this day and age, our debit credit cards provide similar functionality to a traditional credit card.
We can book holidays online, pay bills over the phone and buy from online stores all with our everyday debit credit cards.
Yet many of us still have personal credit cards. Maybe you like the security of a credit card as back-up, maybe you benefit from rewards points on your purchases or, like me, a credit card forms part of your home loan package.
So, now that you’ve got this card that you don’t necessarily need, you might be wondering when a good time is to pay it off.
Is it good to pay off credit cards right away?
The basic way that credit cards work is that you are given a credit borrowing limit, which means you have the ability to make purchases or get cash advances up to your credit card borrowing limit, say for example $6,000.
The way that interest is charged is based on the amount that you borrow and calculated on the outstanding balance each day.
Watch out for different interest rates!
A different interest rate may apply to different components of your outstanding balance. For example, if you got a bit loose last month because every flamin’ person you know decided to have a birthday, get married, or have another kid, and you had no choice but to, not only buy a gift, but also party on with them like it’s 1999; then you might have a carry-over balance on your credit card into this month. This carry-over balance may incur a different (usually higher) interest rate than purchases made in the current month. And, if you’re still strapped for cash this month and need to make an ATM withdrawal using your credit card ‘just this one time’, you’ll be slugged with a higher interest rate again on the cash-advance!
The good news is many credit cards will offer an interest-free period (e.g 44 days or 55 days). But you need to understand how these interest-free days work, so that you don’t get caught out.
Basically, the interest free period is based on your statement period, NOT on when you make the purchase. So, based on a 44-day interest-free period, if your statement period begins on the 1st of the month and ends on the 30th, then all the purchases you made between the 1st and the 30th will need to be repaid in full 14 days after the 30th in order to not incur any interest.
Does that make sense?
So, in actual fact, 44-days is the maximum interest-free period. Because if you buy something on the 14th of the month, then it is only interest free for 30 days, or if you buy something on the 24th of the month, it is only interest-free for 20 days.
The most important thing to note is: if you do not make full payment by the due date, then you may forfeit the interest-free period for the whole statement period. Ouch!
Here is a visual representation:
Be very careful of cash-advances
In most cases, interest is charged on cash advances immediately. There are usually no interest free days on cash advances – even if you have an interest-free credit card. Make sure you read the fine print.
So, after all that, is it good to pay off credit cards right away?
Well, my basic philosophy says “Yes”. And a very big “YES”.
If you are going to use a credit card – pay the whole thing back the second you have the ability to.
Why? Well, debt adds stress. And nobody likes stress. Little bits of credit card debt here and there can quickly spiral, as you begin to make credit card debt a habit and part of your everyday life. A well-structured household budget will not rely on the use of a credit card.
Click here to read “How to Take The Stress Out Of Household Budgeting”
The banks aren’t stupid. They have hundreds of reasons why you should have a credit card: Rewards points, back-up for emergencies, interest-free periods, low rate cards, 0% balance transfers.
They want credit cards to become a staple in your life.
Now, in saying all that, I have and use a credit card.
The reason I have one is probably the only reason I can think of to have one.
And, you know what?
It’s not even that good of a reason!
Here’s the one exception to having a credit card and where it’s not good to pay it off right away
The pre-requisite is that you need to be controlled with managing your money.
So, here’s the scenario:
- You have a home loan
- You have an offset account
- You have a credit card with an interest-free period.
Here’s what you do:
- Leave all of your income that you would usually use to cover your everyday expenses (such as groceries, fuel, etc.) in the offset account.
- Use your credit card to cover the cost of your everyday expenses throughout the month.
- And then, just before the due date of each credit card statement, pay off the total credit card balance using the income that you left sitting in the offset account.
The benefit of this is that the money in the offset account will be reducing the amount of interest you pay on your home loan for that period, while you use the credit card to cover all of your expenses. And then, because you pay the full amount owing on the credit card statement before the due date, no interest will be payable on your purchases.
You could pay off the credit card earlier than the due date if you wanted, but you would be reducing the amount of time that your income sitting in the offset account reduces the interest on your home loan. So, this is why sometimes it’s not good to pay off credit card debt right away.
So, what’s the actual benefit of employing the strategy above?
Well, let’s say that your credit card limit is $6,000, which also happens to be your living expenses for the month. Assuming that your expenses are spread evenly over the month, and the interest rate on your home mortgage was, say 5% p.a., then the net benefit is about $12.50 per month.
Average credit card balance over month,$3 000
Savings on home loan by using credit card,$3 000 x 5% = $150 p.a.
Savings per month,$150 divided by 12 months = $12.50/mth
So, really, is it worth the hassle?
Well, I guess, the savings above should cover the Netflix bill! (… and give you a few rewards). But that’s about it!