Guide to Credit Cards: How to Avoid Borrowing From Credit Cards
We've seen that borrowing money from credit cards in the form of "carrying a balance" is a terrible strategy for most consumers, because the interest rates are far higher than other types of loans. So how do you avoid borrowing money from credit card companies?
If you currently carry balances on your credit cards, pay them off as soon as possible. There are various ways to do this:
- Use cash. If you have available cash, consider using that to pay off as much of your credit card debt as you can.
- Redirect savings. If you make monthly contributions to a retirement or college savings plan, redirect those payments to paying off your credit card debt. Why? Because the interest rate you pay on credit card debt is generally higher than the after-tax return you can expect from the stock or bond markets. The exception is if you participate in a retirement plan where your employer matches your contributions. In that case, it's probably worth maintaining your retirement plan contributions.
- Roll your balances into zero percent debt. Credit card companies periodically offer zero percent financing. You can find more discussion of this in Low-interest rate credit cards in this Guide.
- Pay off credit card debt with a mortgage. The cheapest type of loan is a mortgage, because it's a long-term loan secured against your house and it's tax deductible. The price of mortgages is also kept low because the mortgage business is highly competitive, developments in the financial markets have improved the liquidity of the mortgage market, and the price of mortgages is effectively subsidized by the Federal Government via Fannie Mai and Freddy Mac. Taking a secured loan has one serious disadvantage, though. If you default on your payments for long enough, you could lose your home. So switching unsecured credit card debt for a (secured) home mortgage makes a lot of sense, but only if you are not so mired in debt that you'd risk defaulting on your mortgage.
- Consider a home equity loan. The interest rates are slightly higher than on mortgages, but home equity loans are also tax deductible. Like mortgages, home equity loans are secured against your house, so don't switch credit card debt to a home equity loan if you think there's a high probablity you'll default on the payments.
- Borrow from your bank. If you can't get a mortgage or a home equity loan (for example if you don't own your home), go talk to your bank about getting an overdraft. Compare the fees and interest rates on a bank loan to your credit card loan, and you'll probably find that it will cost you less.
Never use your credit card as an ATM card. Withdrawing cash from an ATM machine with a credit card counts as a loan. You'll start paying interest from the moment you receive the cash. So you should destroy the PIN number sent to you with your credit card, and erase it from your memory.
Never use checks sent to you by your credit card company. Tear them up as soon as you receive them. If you use the checks, you'll be borrowing money and paying interest from the moment the check is cashed.
Ensure that you pay off your credit card balance in full each month. There are three ways to do that, and they're what we'll look at next.
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