If you’re the type of person who carries debt on your credit card from month to month, you should always have one “clean” credit card in your wallet, says Bob Sullivan of Red Tape Chronicles in his new book, Stop Getting Ripped Off: Why Consumers Get Screwed, and How You Can Always Get a Fair Deal. A “clean” credit card is one that you know can always get paid off in full if you use it, and you only whip it out for emergencies. For some consumers, this results in paying less interest and fewer penalties. In an excerpt he’s sharing with Consumerist readers, Bob explains how it works:
FROM Stop Getting Ripped Off: Why Consumers Get Screwed, and How You Can Always Get a Fair Deal:
“Naturally, you can’t always control when you make credit card purchases and payments. If you could, you wouldn’t be using credit cards in the first place. If you are like 50 percent of Americans, you run a balance each month. And if you are like 99 percent of Americans, when you run a balance, you keep using that credit card, keep racking up interest charges, and pay up thinking there isn’t much you can do to pay less. Well, there’s a lot you can do— you can use the clean- card strategy. Put simply, you should always have one “clean” credit card in your wallet or purse; a card that you know you can pay off in full every month. Here’s why.
Recall the “fall from grace” that occurs the moment you don’t pay your credit card bill in full on time. The lure of credit cards is the free thirty- day loan you get when you buy something with plastic. As long as you pay up by the due date, you pay no interest charges. This is called the grace period. But the first time you are late, the grim reaper appears. Interest charges now accrue immediately on all future purchases. Roughly speaking, you pay $1 per day for every $1,000 you borrow with a high- rate credit card, or about $30 per month and $360 per year (based on about a 32 percent interest rate).
Scenario 1: You have a card with a $100 balance and a second, “clean” card. You make a $1,000 purchase on the first day of the month will the clean card and pay the card off thirty days later. Interest charges: Card 1 = $3; Card 2 = $0.
Scenario 2: You have a $100 balance on your credit card. You make a $1,000 purchase on the first day of the month and pay off the entire card on the last day of the month. Interest charge = $33. That’s a $30 difference! Now, spread that impact out for an entire year and you’ll hit $360.
Once again, I’ve oversimplified the math to show the impact, so let me make the scenarios a little more realistic. In this case, however, you’ll see how the clean- card strategy can save you even more than the pay- early, buy- late strategy p. 91
What I really want is for you to have two credit cards that you use in very different ways.
Card one is a “charge card.” You make all your workaday purchases with this card. You vow to whatever God you believe in that you will pay off this card in full every month on time. To make sure you do that, you sign up for electronic bill pay at your bank and send a payment to the credit card firm automatically every month five days before the due date. You make the payment for your average budgeted amount; you can always manually adjust the amount.
Card two is a “ line- of- credit card.” You pull it out for big, emergency purposes that you can’t pay off in full within thirty days. Then you put it back in your wallet, purse, or holster, with the safety latch on.
This will have two important effects on your credit card spending. One immediate improvement: You will have a much better grasp on your debt. Revolving debt, where you are constantly adding and subtracting to the total, tends to get murky for users. When things get murky, your financial brain checks out and gives up.
When you are a serial revolving- credit user, you lose track of what you owe, and more important, you lose grasp of when you will pay it off. A single credit card with a $3,500 balance that never grows is manageable. You know that paying about $100 a month, you’ll pay it off in about three years. On the other hand, a card with a $3,500 balance that is used to make $300 in purchases this month, then $50 next month, then $254 the following month, while you make $125 payments each month, except last month when you only paid $75 . . . well, I’m not going to tell you how long it will take to pay that off. I want you stop living like that. Dividing your purchases up into “charge cards” and “ line- of- credit cards” will help you get your head around your debt and your financial situation.
But that’s just a by- product of the strategy I’m pushing here. Remember, I want you to nickel- and- dime the credit card company. I want you to make math work for you. I want you to save a lot of money by making small adjustments, just as banks do. Watch what happens when you take those everyday purchases off your credit card balance sheet. p. 92
Let’s say you use your card for everything, perhaps in pursuit of airline miles, for example. To make the math easy, say you spend $1,000 every month on lunch, dinner, gas, etc., using your card. That’s $12,000 in spending each year. Of course, you use it for bigticket purchases, too, and you can’t pay it off every month. Let’s say you could afford to pay off the workaday $1,000 in charges every month. But because you put all those charges on one card, you are borrowing $1,000 for thirty days every month. Remember that simple $ 1- a- day formula? Using your card this way costs you close to $365 every year— just for the everyday purchases you make.
Now, I’ve been quite generous in my calculations. In reality, you’ll probably wait forty- five days to pay off those everyday purchases, thanks to the whims of billing cycles, meaning you’ll be paying closer to $500 in unnecessary interest charges every year.
Of course, you will still have to pay interest on that line- of- credit card. But you’ll be saving a sizable chunk of money just by picking your plastic wisely, and not borrow money for every purchase you make.
A special note to mileage addicts: Now I know many of you love the miles or points you rack up by using that same card over and over. I’m sorry to say that many of you have been hoodwinked. Any benefits you receive from a mileage card are completely nullified the moment you run a balance and start paying interest charges. In all likelihood, you’ve already paid a yearly membership fee. We all know points aren’t what they used to be, with all the restrictions the airlines put in place. Now consider my math above: Just by removing your daily charges from your card, you save enough money each year to buy a plane ticket! Unlike points, cash never expires!
The moral of the story: Always have a clean card. If financial Armageddon strikes and your “clean” card becomes dirty, use the exceptional tool of getting a third card and make that your clean card. But end the game there. If you feel a need to get a third clean card, you’re in an entirely different financial place, and you need emergency help with debt relief. We’ll discuss that in the “regular revolver” advice section.”