For those who know how to use one wisely, a credit card can be an avenue towards improving one’s financial health. When used responsibly, a credit card can be a great way to build creditworthiness, which is essential for securing better interest rates on future cards as well as other financial privileges like loans. Your card may also offer exceptional perks, such as cashback, points, and travel rewards, that will add value to your everyday spending.
However, if you aren’t careful about how you use your credit card, it can become a source of financial strain instead of financial empowerment. Credit card mismanagement can easily lead to mounting debt, high interest charges, and difficulty making payments. In the long term, these consequences can affect your credit score, your eligibility for a mortgage or other loans, and your overall financial future.
Although it’s easy to get trapped in credit card debt, it’s possible to avoid it if you know what you’re up against. To that end, here are some tips that should help you curb your risk of falling into bad debt:
1) Understand the Difference Between Good and Bad Debt
Before you can effectively manage your credit card and avoid bad debt, you should first know the difference between so-called “good” and “bad” debts. Recognizing this distinction should enable you to use your credit card in a way that supports your financial goals rather than hindering them.
Good debt typically refers to borrowing that helps you build wealth or improve your financial situation in the long run. For instance, taking out a loan for your education or a mortgage for a home can be considered good debt, as these investments have the potential to appreciate in value over time.
On the other hand, bad debt is the kind that doesn’t add value to your life and often comes with high interest rates. Common examples include carrying a large balance on your credit card or taking out payday loans. These types of debt can quickly snowball as interest charges pile up, making it difficult to pay your way out.
You should think about what actions will place you in a state of good debt or bad debt when completing an online credit card application, for example for a Landers Cashback Everywhere Credit Card by Maya. This will help you become more aware of how you plan to use your credit card and avoid the cycle of unnecessary spending.
2) Set a Spending Limit on Your Credit Card
An effective way to avoid bad debt is to set a spending limit on your credit card. This will help you stay within your means, ensuring that you don’t overspend or accumulate debt that’s difficult to pay off.
But this doesn’t necessarily mean you need to reduce your credit card limit. It’s more about consciously deciding in advance how much you’re willing to spend on your card each month. For example, if your monthly budget for discretionary spending is PHP 5,000, make sure that your credit card charges don’t exceed this amount.
A reputable credit card issuer may also offer tools that will make you even better at managing and tracking your spending. Maya—the number one digital bank in the Philippines—enables users to assign daily spending limits to different types of credit card transactions (e.g., daily spending limit, online payments, and cash advances) via the Maya app. Use these tools to control how much you’re spending so that you stay within your budget.
3) Maintain a Low Credit Utilization Rate
Credit utilization refers to the percentage of your available credit that you’re using, and if you consistently use a larger portion of your credit limit, you’re more prone to accumulating debt that becomes harder to pay off. A high credit utilization rate signals to lenders that you’re relying too much on borrowed money, which can make them view you as a higher risk for defaulting on payments. This could lead to higher interest rates on future loans or credit applications, or even difficulty being approved for credit altogether.
The general rule of thumb is to keep your credit utilization below 30%. Financial experts recommend this as the ideal credit utilization ratio for a healthy credit score. For example, if your credit card has a limit of PHP 20,000, you should aim to use no more than PHP 6,000 to ensure you’re not overextending yourself.
4) Avoid Making Minimum Payments
Even though making the minimum payment on your credit card may seem like an easy way to get through the month, it can be a costly habit in the long run. The minimum payment is often only a small percentage of the total balance, meaning that most of your payment goes towards interest charges rather than reducing your principal balance. As a result, your debt can continue to grow, even if you’re making payments regularly.
If you’re unable to pay in full, you should still always aim to pay more than the minimum. Paying even just a little extra over the minimum can significantly reduce the interest you’ll have to pay and help you get out of debt more quickly.
5) Pay Your Balance in Full Every Month
While paying more than the minimum is a fair enough strategy to reduce debt faster, paying your balance in full every month is still the best way to prevent debt from snowballing. Whenever you pay the full amount, you’ll be able to stop the cycle of interest and avoid the temptation of utilizing more credit. This approach will help you preserve your financial health and, unlike making minimum payments, prevent your debt from growing and negatively affecting your credit score.
To help you achieve this, set up reminders on your phone or calendar. Having consistent reminders will help you stay on top of your payments and avoid falling behind.
With careful planning and mindful spending, you can maximize the benefits of your credit card and avoid falling into “bad” debt. Take proactive steps today to stay in a state of good debt and use your credit to build a strong financial foundation for the future.
