Millennials list this troubling reason for owning a credit card -- and it could cost them big time.
There are lots of good reasons to have a credit card, including building credit and earning rewards. But, there are also some very bad reasons. And unfortunately, millions of millennials have a terrible reason for carrying plastic.
Why is this such a major credit card mistake?
Owning a credit card to purchase unaffordable items is a major mistake for a very clear and obvious reason: The credit card does not actually make the purchase more affordable. In fact, it makes it less affordable.
While it is true that you can charge an item you can't pay for all at once and can take that purchase home right away, doing this is a really bad idea. When you do this, you've committed a portion of every future paycheck to paying off your credit card bill until the balance has been paid down. Since you now have less money going forward, that makes every other purchase less affordable and makes it harder for you to live on a budget.
Charging purchases also makes each item cost more thanks to the interest you'll owe. And credit cards are a very expensive way to borrow, as cards typically carry an interest rate well above other kinds of debt.
The average interest rate on a credit card in mid-August of 2019 was 17.71% APR. If you spend $1,000 at 17% APR and then make minimum payments equal to 2% of your card's balance or $20, it would take you 137 months to become debt-free and you would pay $1,171 in interest -- more than doubling your purchase cost.
Finally, charging items you can't afford can hurt your credit score. When you charge on your cards, that affects your credit utilization ratio. This ratio, calculated by dividing the credit used by the credit available, needs to be as low as possible -- ideally below 30% -- to avoid damaging your credit. Charging expensive purchases you can't afford, or charging a bunch of purchases you can't pay off right away, results in a high utilization ratio and a lower score.
What should you do instead?
Instead of using your credit cards to pay for purchases you cannot afford, you should save up to pay for items in cash. If this isn't possible:
- Consider a lay-away plan. While not as common as it used to be, lay-away is still offered by many stores. It allows you to make payments for an item you want to buy over time and take the item home when it's paid off.
- Look into a personal loan. Personal loans typically have APRs well below credit card APRs, which means they can be a better way to borrow for a big purchase you need to make ASAP.
If you must use a credit card to buy an item you can't afford, look for a card offering a 0% promotional APR on purchases for a limited time. If you can get approved for one of these cards and make all of the payments before the promotional period ends, at least you won't pay interest on that expensive item you buy.
Unfortunately, even with this approach, you could still hurt your credit if you max out the card. And you will still make affording future purchases more difficult since you're committing income you haven't yet earned to paying it off -- with the risk that you might not be able to pay it off at all.
Credit cards are not a good tool to buy things you can't pay for outright
If you're one of the 35% of millennials who think a credit card is a good way to buy things you couldn't otherwise afford, you now know why that's not the case.
Use your cards only for purchases you can pay back at the end of the statement cycle so you can get rewards and build credit, and save up to make those major purchases in cash instead. You'll be a lot better off in the long run.
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