Let’s talk about credit card traps.
I don’t know why but we have the tendency of thinking that with these little plastic things called credit cards, banks are doing us a favor. Well, they are not.
Everything around credit cards is designed to make you pay money you don’t have, so today, once and for all, we are going to discuss all credit card traps and how to avoid them, if you don’t want to dig your own financial grave.
1. Paying only the minimum
Number 1 – Paying only the minimum. Now the worst mistake that most people make is saying “I can afford the minimum payments, so I can buy the thing that I want.” So basically we think they are doing us a favor, while instead they are bleeding us out little by little. Paying the minimum payment, like 2, 3% of your balance only saves you from late fees, but still when you make the minimum payment your balance will always be charged with interest, and the interest can be something like 18, 19%, or even more.
So you want to buy an iphone, it costs you 800$ and you say, come on, 2% of it is like 16$, I can pay that. Then you buy a sweater for a 100$ and you use another credit card and you’re like, pff, 2$ per month, that’s a joke. And so you go on maybe maxing out all your credit cards because you think you can buy stuff as long as your minimum payments are not too high. Wrong. If you pay the minimum payment all the rest of your balance is subject to a really high interest rate of like 19% and this is going to trap you and make you poorer and poorer for life.
So what happens is that while you pay the minimum payment even if you stop using that credit card in the months to come your balance will be constantly charged with interest and in the end it’s going to take you years to pay it.
Just to give you an example, if you have a credit card balance of $2,000 and your minimum payment is 2%, you pay 40$ every month. Assuming you don’t buy anything more with that card you are going to need 100 months, meaning more than 8 years to pay off those $2,000 and the interesting thing is that you will have paid not 2000, but 4000$ in the end. Yes you’ve heard right. Almost $2,000 more than what you owe just because of the 19% interest.
Basically the interest rate in the credit card works just as the return when investing in the stock market in the long term, only the other way around. I always tell on my videos how important it is to invest in ETFs like the S&P500 long term because even if you get only 9-10% return, in the long term this is going to grow to incredible sums. In the same way 19% interest on a credit card compounds and in the end you are going to pay more in interest than what you actually owed. So my suggestion here is pretty easy: pay off your credit card bill in full every month.
It’s actually that easy and whenever you can’t pay the amount in full, you need to realize that this means you spent more than what you should have. So you make a sacrifice the following month and you pay everything in full.
Whenever you decide to buy things you can’t afford and pay the minimum, there is only one direction that your finances can take: your debt is going to grow and grow and in the end, paying it will become almost impossible. So decide to buy something not based on your ability to pay the minimum payment, but on your ability to pay for the whole thing.
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2. Points and bonuses
Alright, Number 2 is Points and Bonuses.
Now, I used to justify purchases because I either got discounts, or points, or cashback or whatever. You know, you get 2% back so it’s not really the 2% that is going to make you wealthy, you know that, but the idea that you are going to miss that cashback if you don’t buy, the idea that maybe in the future you’re going to want that thing and you’re not going to have a the same cashback or discount, urges you to buy now.
So there’s actually nothing intrinsically bad in getting a cashback or a discount, but the problem is the switch that turns on in our head when we see a discount, and by the way a huge number of studies have indicated that people spend more when paying with a credit card. How much more? It depends on the study. But many studies go around 15-20% more than paying in cash. So even if you get like 2, 3, 5% back, if you are spending 15-20% more overall, in the end you are not really gaining something.
Same thing goes for the points. Some people, many people, are point chasers. It’s like when you have a collection, the more you have the more you want. But if you are not able to pay off your credit card in full at the end of the month, you end up paying interest and you are basically canceling out any bonuses received. In fact, you’re paying for them.
Many credit cards offer sign-up bonuses, For example, they offer $300 cash back if you spend $2,000 within the first three months. So this pushes you to spend the $2,000 even if in reality maybe you would have spent $1,500.
So my suggestion here is never chase points. Whenever you want to buy something, do it based on need and not on rewards you might receive. And of course if you have the option to buy a product with or without cashback you go for the option with cashback if it doesn’t cost you more.
3. Payment Coupling
Alright, Trap Nr. 3, Payment coupling. If you don’t know what this is, don’t worry, after this you’ll be able to do like Ross Geller in friends when he used to say scientific stuff to his friends, but I think that this might actually be really interesting so listen up.
According to a famous study by professors Prelec and Simester of the Massachusetts Institute of Technology, we spend up to 100% more when paying with credit cards compared to cash purchases. Yes, I said 15-20% before but I also told you that each study has a different number. So, 100%. Anyway, without going into detail on the study, the question is, why do we spend more with credit cards than with cash? In this, we have a lot to learn from the Germans, who even after covid still consider cash as king and prefer paying with cash than with credit cards. And in fact, Germans carry little to no credit card debt.
But why is it that if we pay with cards we pay more? This irrational overspending is explained by the Payment Coupling Phenomenon.
Whenever we buy an item with cash, the money is actually leaving our pockets so this process makes us emotionally uncomfortable. However, when we pay with a credit card, there is a time period between the time of the purchase and the moment we have to actually pay for it, and this makes the cost seem less relevant. So what happens is that we tend to solely focus on the benefits that we are getting by buying the item, leaving the cost completely out of our thoughts.
This phenomenon is called Payment Coupling and not only is the reason why you spend more with a credit card than with cash, but is also why now everybody offers purchase options like “buy now, pay later” or “pay on installments”. Every time we know that we are going to pay for something in the future instead of now, and possibly little by little instead of all together, it feels less painful and we are led to spend more.
So my suggestion is: Don’t Carry Your Credit Cards With You. Learn to do like the Germans and take some cash out with you. Like 100$.
Just take your cards with you when you really need it, like when traveling or to a doctor’s appointment, but otherwise, just keep them home.
4. Wanting to build credit
Number 4 is Wanting to build credit. The truth is, you don’t need to build credit as everybody says. The idea of having to spend money with a credit card to build credit is going to make you justify spending huge sums, like an expensive laptop or cars or whatever, because you say “at least I’m building good credit.
But in reality, you don’t need that.
There is something called manual underwriting: if you go buy a home and you’ve never had credit cards before, as long as you have pay stubs and a history of bills that’s all they need to give you a credit profile. So using Manual underwriting instead of having a computer evaluating your ability to repay a loan based on your credit score, you’re going to have a person in the bank that personally reviews your finances and determines whether or not your application should be approved.
So yes, it’s true that building a good credit score helps you in that, but it’s 100% not necessary. Therefore, wanting to build credit shouldn’t be a reason for you to spend more.
5. Balance Transfer
Alright, Nr. 5 is Balance Transfer and like many others, this is a trap because it’s based on giving you an advantage but in the end, often you end up with more problems than before.
Now what is balance transfer? Let’s say you max out a credit card and now you are paying a bunch of interest on that card, ok? And this is bad, you don’t want to pay interest. So then you get the option to transfer this balance to a new credit card which offers a promotion with which you’re not going to pay interest for the first 12-18 months. And usually you don’t pay much for the transfer, it might be something like 5%, so let’s say you have a $2,000 balance you pay $100 for the transfer but still it’s better than paying interest on the $2,000, right?
But the problem is, what most people do is, after they transfer the balance to the new card instead of paying off that card, they build up new debt on the old credit card. So now you find yourself with 2 cards with a balance, you know what I mean? And the reason why you do it is that on the new card you don’t pay interest for 12 or 18 months.
So it’s always this payment coupling factor that messes up with you. You know you are not going to pay interest, so you postpone paying off the card. And since you didn’t change your lifestyle, but you merely made a transfer, you fall into the trap of building new debt with your first card (laugh). Never make this mistake. Use balance transfers to avoid paying interest if you already made the mistake of building debt, but don’t create more debt just because now you can.
6. Introductory Rates -The 0% Introductory APR
Number 6 is Introductory rates or interest free periods. Most credit cards offer low interest rates or even zero interest for a short period of time to convince you to sign up. If you pay your monthly balance in full, this won’t affect you; if you don’t, this is a common and painful trap. Some retailers offer 12-18 months with no interest. However, once the interest-free period ends, interest rates can be as high as 30%, and the credit provider is under no obligation to remind you when that period ends.
So there are basically three big traps to this:
Number 1, you rack up debt you can’t afford. Some people treat cards with 0 percent intro APR as free money. Since your purchases don’t accrue interest, it’s easy to make excessive purchases on the card and tell yourself you’ll pay off the balance later. Only the situation gets out of control, you don’t manage to pay off your balance in full before the zero-interest period ends, and you start paying incredible interest.
So how do you avoid this? Don’t make any purchases you can’t afford to pay off in the same month before this 0% period expires.
Number 2, you don’t make the minimum payments. Some people assume zero-interest credit cards don’t require minimum payments. This is a common misconception that will cost you fees and damage your credit score. Not only that, credit card providers are not there to remind you of every single clause of the contract, and one of them is often that if you miss a payment you lose your promotional interest rate. So you start paying interest without even knowing it.
And the 3rd problem is, You forget when the intro period ends. This is a mistake that many people do. They open a 0 percent intro APR card and they intend to pay off their balance after 12 months, before the promotional period ends — only they forget to do it when the time comes. So everybody has a phone with a calendar. If you get one of those cards with a promotion, first thing you need to do is set an alarm on your calendar to remind you when the promotion is going to end, and don’t trust your memory alone.
7. Late Payments
Now nr. 7 is late payments. You miss one single payment, you might say “it’s not a big deal”. Well it is a pretty big deal, it is a massive deal. One mistake, and that stain is going to stay on your record for 7 years. So whenever you want to get your first apartment, your first mortgage, they are going to ask you “why did you miss that payment?”.
Remember, the interest of the lender is always to be sure that if they give you money, you are going to be responsible enough to always pay them back and never make them lose money. So it doesn’t matter if you missed one, two or 10 payments, it always makes you untrustworthy in the eyes of the bank or whoever lends you money. So never miss a payment and the solution to this is to always avoid maxing out your credit cards, keep your expenses low and always buy only what you can afford.
Credit card traps – Conclusions
Alright guys, these were 7 credit card traps you absolutely need to avoid. Don’t underestimate them because, seriously, they are going to affect you financially your whole life if you are not careful because piling up debt is kind of like an avalanche, at some point it gets over a level that you cannot cover with your income anymore, it grows out of control and it can literally destroy you financially.
But anyway, if you enjoyed this video, please be nice and support me with a like and of course subscribe to the channel for more content like this. Check out my channel if you want, you’re going to find interesting videos on finance and investing, with a taste of productivity and self development tips. Thank you so much for watching ‘till the end and as always, I’ll see you in the next video. Ciao!