Finance 103 – Credit card management

Credit is a pit bull that can protect you, love you, then turn and bite you in the ass. This is the most complex financial concepts that present the biggest risk as well as reward to a household’s financial success. Credit is the promising to spend future earnings in order to obtain a good or service today. However, when terms of loans fluctuate, or ones income or total debt changes, promises tend to be broken. Leveraging is an effective money management tool that we all should use and master. If not, it will master us.                     

The definition of interest is ‘the cost of money’. If you carry $20,000 in credit card debt, you may end up paying an amount of interest on that debt equal to college tuition. So when your son needs college funds you won’t have it, but the CEO of Citibank will use your interest payments to pay for his son’s college education. But don’t worry, there is a chance that his son will be the boss of your son and hence your son will learn from that ivy league education indirectly.   Oh yeah, Citibank gives student loans.

If you are one who loves a good sale at Macy’s and you run to the mall to save 20% and then turn around and purchase on a credit card that charges you 20%, guess what… If you take two years to pay off that card, you will pay up to 20% more than the regular sale price. 

For every income there is an optimal amount of credit card debt that should be held. This limit depends on many factors in your overall financial strategy, but without a strategy you can have as much in credit debt as you want because collapse is eminent without a strategy.

I divide credit into three different categories: revolving credit, installment loans and collateralized debt (real estate). But the below is in regards to managing credit card debt.

In managing credit cards, on an excel spreadsheet list:
In column 1 – All your credit cards
In column 2 – List the interest rate charged
In column 3 – List your total credit limit
In column 4 – List the outstanding balance
In column 5 – Place a formula that will divide the outstanding by the total credit limit.
In columns 3 & 4 – At the bottom add the formula to sum these respective columns

Generally your goal should be to work towards all of the following:

1. Take the sum from column 4 and divide it by the sum of column 3 – If this number is greater than 50% then you either don’t have enough credit limits or you have too much outstanding balance. Work towards lowering this number as much as possible.
2. On column 5, work towards only using a maximum of 50% of all credit limits on each card. Once your used limit is over 50% it affects your credit score negatively. As well this extra unused credit may be used in an emergency, in addition to the 3 months (5 months if you are a homeowner) of liquid emergency savings.  Credit card companies have been lowering limits during this economic crisis. One of my clients limit was cut below his outstanding balance. We had to fight the credit card company to waive the over the limit fee they had the nerve to charge.
3. Only carry one card with you at all times. Choose the one with the lowest interest rate.
4. I highly recommend not using any department store credit cards. Never cancel a current card unless it has an annual fee. But have the discipline to not ever use the ones that insult your financial sensibilities with a high interest rate.
5. THE MOST IMPORTANT MONEY SAVING TIP IS TO Only pay the minimum payment on all credit cards, except for the one card with the highest interest rate. Pay as much on that one as possible each month.