How to Avoid the Credit Trap

As the US struggles with one of its deepest recessions since the 1930s, credit is on everyone’s mind. Mounting layoffs, declining benefits, and depressed assets are leaving people without steady streams of income and forcing them to question how they will pay their bills. Paying by credit card has lost its appeal as consumers worry about getting caught up in a downward spiral of debt. But credit cards aren’t evil in and of themselves. Used responsibly they can become an important spending tool that can also pay you back.

Before you can begin putting credit cards to work for you, you should understand that they can be seductive. The New York Times reports the average household’s current credit card debt is $8,565. That’s a lot of money, and it’s easy to accumulate this much debt without even noticing, something that doesn’t happen when you are paying by cash (your wallet will be noticeably lighter).

• Spending money is easier with a credit card than with cash because you don’t feel like you’re spending money.
• Individuals might be less likely to pay attention to how much they are spending or question their bill when using a credit card.

While it easier to spend money you don’t have with a credit card, there are real benefits to owning one.

• You have electronic records of your spending month to month.
• Credit card issuers are lending you money (for free!) for a month at a time.
• You can earn rewards like miles or cash back for the money you spend and receive other benefits that accompany many cards.

Using a credit card is also an integral part of establishing and strengthening your credit history, a report of your financial health used by lenders, employers, and others to determine if you are a risky bet.

If you use a credit card and have debt or are thinking about applying for a card, here are some tips for getting yourself out of the debt trap, finding the right card to earn rewards for your spending, and then keeping your credit card debt at zero.

Step 1: Pay Down Existing Debt-Start Yesterday

Fifty-five percent of credit card holders carry a balance month to month. Paying off these balances with high interest rates will take consumers years and rack up billions of dollars in finance charges.

If you are someone who carries a balance month to month on your credit card, paying down your existing debt is the first step towards improving your financial health and getting on the right track to using your credit card responsibly. Begin by transferring your outstanding balance to a card that charges no interest on balance transfers for up to 12 months. Most issuers offer a few cards with this powerful feature. After those months pass, transfer the balance again to another card with no interest and keep paying down your debt. Find one area where you can reduce your spending each month, like dining out or going to the movies, and funnel the additional savings into your credit card payments.

Step 2: Get the Right Credit Card – What Should You Look For?

There are hundreds of cards out there, and picking the right for everyday purchases is daunting. The first thing to look for is no annual fee. Many issuers offer great cards that don’t require an annual fee. Often, the annual fee isn’t justified by the card’s benefits, and it creates an extra expense. If you are looking for a card that offers rewards for a specific program like American Airlines miles, you might not have a choice. If this is the right card for you, try to get the first year free. You can also call the credit card company and try negotiating for a lower fee if you have a strong credit score or a history with the company.

Step 3: Get Rewards for What You Spend

You are going to be spending money on your credit card, so you might as well earn rewards for your purchases. First, determine whether you want to receive points, miles or cash back. Next, evaluate your spending patterns and try to find a card that offers bonus rewards for the purchases on which you spend the most. You will find many cards that offer bonuses for groceries, restaurants, travel, and numerous other categories. Mint.com can help you see where you spend your money each month and get a card that fits your spending patterns.

Step 4: Don’t Spend More Than You Can Afford

And now, the catch: Once you have the right credit card, the most important thing to remember is not to spend more than you can afford. In other words, make sure you can pay your credit card bill in full each month. Perhaps this message sounds easier said than done or overly simplistic, but it is by far the most important part of using your credit card wisely. By adhering to this principle, you will be able to take advantage of the benefits of using a credit card while avoiding the debt trap. What is a good tactic to accomplish this? For one, make reasonable monthly budgets for yourself and keep track of where you spend. If you exceed one of your budgets, figure out what pushed you over and how you can cut back. By simply monitoring your spending closely, you will find you are spending more than you previously thought and be able to determine how to adjust your spending.

Getting the right credit card for your daily use and staying out of debt while using it are not exact sciences. Some approaches work well for some and not others. However, by following the broad guidelines outlined here, you will set yourself on a path towards financial health. Don’t spend more than you earn and pay your credit card bill in full every month. Then make your card pay you back in the form of rewards.

After that, be creative. Try one approach to stay within your spending goals for a month or two and see if it’s working. If not, try something different. Hopefully, the right solution will reveal itself, and you will be able to take full advantage of what credit cards can offer.

Check out Mint’s credit card guide, credit card help and credit card calculators for more ways you can avoid credit traps.