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By Christy Bieber, The Motley Fool
Most people need to have a credit card. A credit card makes it easy to pay for purchases without carrying around a bunch of cash. Credit cards also allow you to earn rewards for everyday spending, and can help you to improve your credit score and build a positive credit history.
While using a credit card can help you in a number of ways, mistakes with your credit card could be incredibly costly. Some mistakes can do more financial damage than others -- so be sure to watch out for these four especially costly credit card errors.
1. Paying only the minimum
One of the biggest and most expensive mistakes you could make with your credit cards is charging up a balance and paying only the minimum due instead of paying your card off in full. When you pay only the minimum payment on a credit card, you’ll be trapped in debt for months or even years -- and will end up paying hundreds or even thousands of dollars in interest in the process.
Say you end up with a $5,000 credit card balance on a credit card with a 16% interest rate. If you make minimum payments equal to the lesser of 2.5% of the balance or $25, you’ll end up paying back your debt over 195 months. That’s more than 16 years. During that time, you’ll pay $5,010.05 in interest -- which means you’ll more than double the cost of all the stuff you purchased to run up that $5,000 balance.
You don’t want to end up stuck in debt forever, so don’t charge more than you can pay off when your statement is due.
2. Making a late payment
When you pay your credit card late, you could be charged a $28 fee the first time, and a $39 fee for subsequent late payments. These fees are bad enough, but they’re only the tip of the iceberg when it comes to the costs of paying late.
The biggest financial damage from a late payment comes from the impact on your credit score. According to myFico, if you had a good credit score before the late payment, your score could fall by more than 100 points. This drop could have a very real impact on the cost of getting your next loan.
Say you had a 750 credit score before your late payment and your score fell to 650 because you paid late. If you decide to apply for a $300,000 mortgage after your score took its tumble, myFico indicates you’d likely be offered a rate of around 5.105% APR with your new 650 score -- which would give you a monthly payment of $1,630. The total interest you’d pay would be $288,718. Had you maintained your 750 score, you’d have had an APR of around 4.284% -- and a monthly payment of $1,482. The total interest you’d have paid would’ve been $233,447.
In this case, your late payment would cost you $148 extra per month over the 30-year loan term. And the total price tag of that late payment would be over $55,000; that one late payment would be a very costly mistake.
3. Triggering penalty interest rates
Did you know that when you pay your credit card balance late, you could trigger your credit card issuer to raise your interest rate to a penalty interest rate? You could also trigger a penalty rate for violating your cardholder agreement in other ways -- such as bouncing a check you send to pay the card or exceeding your credit limit.
A penalty interest rate could be as high 29.99%, although some cards charge a lower rate. The penalty rate can apply to the outstanding debt balance on your card and can remain in effect on this outstanding balance for up to six months -- or longer if you make another mistake while the penalty rate is in effect.
The penalty rate also applies to new purchases, but could apply indefinitely on purchases made after the rate changes -- so you could end up paying this higher rate forever.
If your interest rate was 15% before triggering the penalty APR, you could end up almost doubling your interest costs by making this mistake.
4. Taking out a cash advance
Finally, taking out a cash advance is another costly mistake because the costs associated with getting cash from your credit card are very high.
Many card issuers charge a fee for a cash advance, such as 5% of the amount of cash received, with a $5 or $10 minimum. The interest rate on a cash advance is also significantly higher than the standard interest rate on a card in most cases. Interest may be charged at this higher rate from the day you take out the cash advance -- with no grace period, unlike with other credit card purchases.
Between the up-front fee and high interest rate, you could end up paying substantially more just to access cash through your credit card. A better approach would be to try to charge what you need -- even if you have to pay a service such as Plastiq, which charges a 2.5% fee to let you pay almost any bill on a card.
Avoid costly credit card errors
Now you know some of the top credit card mistakes to steer clear of. You can save yourself a fortune by avoiding these mistakes and using your card responsibly. Remember to pay on time, refrain from cash advances, and pay off your card balance in full, and you should be in good shape.
