This blog is useful for most of the readers as it helps them improve their cash available for savings and investments by making small changes to your habits and improving your awareness of your income and expenses.
The blog also covers tips to optimize the revolving credit offered by credit card companies.
When it comes to effectively managing your personal finances, your cash flow will play a very important role. Simply put, cash flow is difference between the amount that flows in and flows out of your account during a measurement period (this can be a day, week or month) and impacts your liquidity. Having too much liquidity is not advisable as it diminishes your earning potential. Having inadequate liquidity is will make you borrow more and/ or default.
In some cases, it’s a matter of a few days between expected inflow after the expense has been made. In other words, you have a short-term liquidity crunch. During such times Line of Credit comes in very handy. If you don’t have a Line of Credit, then the other best way is to space out your expenses evenly across the month and schedule your monthly payments a couple of days after you receive your income.
For example, if you receive your salary twice a month on the 1st and the 15th of every month, you may want to schedule your major payments like mortgage, credit card on the 3rd and 17th of the month. If you do this you won’t need to carry cash in your account for a long period of time and would be able to time the outflows and inflows well.
I have covered this aspect in detail in my blog: Optimizing Cash Flow.
Now I will detail out how we can effectively make use of our revolving credit and maximize our savings potential. I will provide you a few tips on how to maximize the benefits that are provided by credit card companies. The main intent of these benefits provided by the companies is to ensure that you spend more and live beyond your means and enter into a debt trap. Their intention is that you would start paying less than the amount due and pay a heavy interest (usually in the range of 16% to 25% APR) on your outstanding amount. Your intention is to stay away from the debt trap.
Sound Credit Card Usage Habits
I will provide a few tips on how to slightly tweak your habits to improving your financial health.
Cashback on Credit Cards
Few of the credit cards provide a cash back to you for using the credit so long as you are paying their dues regularly and your account is not delinquent. The cashback you can generate from your purchases can be a substantial amount and you need to maximize the rewards for yourself as you spend. Standard cards offer cashback of 1% of your purchases. Few other credit card companies will give you higher cashback for specific purchases like gas, travel, groceries. Then we have store-specific credit cards that will give you a heavy cash back (up to 5%) when you make purchases at the store and 1% everywhere else.
This cash back is credited when the credit card statement gets generated. There are a few credit card companies that provide an instant cashback on your transactions. The money accumulates as your rewards balance and you can chose to either transfer it to your bank or pay a partial or complete statement balance. You can setup auto credit of the accumulated rewards. I would advise you to use the accumulated credit as a cash flow balancing mechanism. Transfer the money to your savings account when you are short of funds. Don’t accumulate the amount for a long period as you are not going to earn any interest on this money.
Mileage Award on Spending
As variant of cashback adopted specially by the hospitality and travel industry credit cards is reimbursing you with reward mileage or points that you can use to purchase a hotel stay or book a travel. These companies also have an annual fees for using the card.
There are 2 disadvantages to this first is of course the annual card fees that go down the drain if you are not a power user and second is that the points get converted to money eventually but can be used for specific purposes only like buying air tickets with a specific airline or staying with a specific hotel chain. This would not be the ideal option had you used your cashback card instead but now you are forced to use it.
There are other benefits that such cards provide like free upgrades, additional bags at no extra cost. If you are a power user and like to indulge yourself in luxuries of life then by all means they are a good option.
Cash v/s Credit Spending
A simple answer is use credit where it is accepted if you are good at repaying your credit on time. Use cash where your future income stream is likely to be under pressure and your expenses would spiral out of control. It may sound counterintuitive at first but when you think of it, cash purchases would diminish your spendable amount and make you control your discretionary expenses. Do not use credit where allowed if there is an additional charge for using credit. You would be better off using a bank transfer instead for such cases. Do not use credit at places where your card information is more likely going to be misused (like adult stores).
Balance Transfer Cards
The only time I would recommend that you make a minimum payment is when you use a balance transfer card or make a large purchase using 0% financing.
Balance transfer cards are offered by credit card companies and they would have 2 separate charges – upfront balance transfer fees and balance transfer APR. You should not opt for the balance transfer card if neither of these numbers is non zero. So, you need to get a balance transfer card that would give you 0% APR and $0 transfer fee. The credit is extended usually for a period ranging from 12 to 30 months. Take full advantage of it and ensure you setup an autopay for paying minimum periods throughout the minimum payment period and a scheduled payment of outstanding balance for the last statement before the card becomes interest bearing. This is very important if you need to take full advantage of the 0% financing offer.
You need to have a (much) cheaper source of funds that would pay off your outstanding 0% balance once the promotion period ends. Avoid getting into a debt trap. Even interest on one delayed will let the lender take away all the benefits you hoped to derive from the 0% financing.
Again, I can’t stress enough the importance of setting up autopay and scheduled final payment upfront when you get the balance transfer card. If you forget about the final payment, you will lose money.
If you would like to avoid a future shock of making a big lump sum payment at the end of the promotion period, you can setup equal monthly payments over the promotion period. This may work better for a few of you as you would have better control over your monthly outgo.
Another important aspect is that you should not use the balance transfer card to make any other purchases. The calculations of minimum payments linked to the balance transfer during promotional period and the minimum/ full payments due for purchases after the promotional period are very confusing and you may end up paying interest on the outstanding amount from purchases after the promotional period unless you pay them in full. My advice is to apply for the balance transfer card, transfer the balances and keep the card in a safe deposit locker and never in your wallet.
A key question being asked is where to transfer the balances when we get a balance transfer card. You have one of the 2 options – you can either make large purchases in the first 15 days of availing the balance transfer card or you can transfer the balance to the more frequently used revolving credit accounts. You can actually transfer a higher amount than the outstanding amount on your card and keep a positive credit card balance. For example, you total outstanding balance (i.e. you would owe the credit card company) on your credit card is $4,600 and you transfer $10,000 to that credit card. Then you will have a positive balance on your credit card till you are spend the remaining $5,400 on your card. Till this period is reached you will not owe any payments (not even minimum payments) on your credit card account. Few credit card companies will transfer the remaining positive balance after 3 billing cycles to your bank account or send you a check for that amount and bring the balance back to $0.
It is important for you to ensure that you use the benefits of balance transfer card to your benefit by retiring or paying off more expensive debt. If you will use this feature and let the money accumulate in your savings or current account, you are not doing any justice to yourself or to your money.
Another important aspect to note that the outstanding balance in your balance transfer card would adversely impact the “% Credit Used” parameter (Refer to All you need to know about Credit Score – Myfinancejournal) and usually push it higher than the 20% mark. This will bring down your credit score and keep it there till the time you have the balance is paid off. You need to be aware of this aspect and be discrete with the timing of a balance transfer card purchase. Do not opt for a balance transfer card when you are applying for a loan or mortgage in the next 6 months to a year. You can apply for it immediately after you have closed on the loan or mortgage (in fact, this will be an ideal situation). Don’t spend a lot of time doing this jugglery if you are getting a small amount (less than $10,000) for balance transfer. It’s not worth the effort.
Credit Limit
As mentioned earlier, you will need to keep your spending between 10%-20% of your available credit in order to maintain a good credit score. If your outstanding amount on all your revolving credit accounts is more than 30% of your total credit limit then it’s time to either increase the number of your credit card accounts or still better increase the credit limits on select credit cards. If your credit score is decent then this will not be an issue for you. Few credit card companies would automatically increase your credit limits if they observe you are utilizing a good percent of the available credit and if your credit score is good. If you sum up all credit limits available to you, then the amount would be around $50,000 to $100,000. This means you can spend that much money when required but also means that you should never come even close to keeping that much outstanding balance anytime. This is a sure recipe for disaster and debt trap. You may however use this credit limit as contingent fund to help you with your cash flow and of course clear off the outstanding balance in the subsequent billing cycle. The cardinal rule is that you need to track your expenses at all times and ensure that you take debt only for the amount that you have a payment capacity.
Payments
The first thing that you need to initiate once you receive the first bill for a new credit card is to go to the credit card website and schedule an automated payment of the total billed amount (and not minimum payment or total outstanding balance) on the due date for the payment. This practice will do several things….
- You will always pay your previous statement spend on time
- You will not get referred to collections for non-payment
- You would be able to use the credit for a period of 45 days at no interest
Once you do this, take the next important step of adding these expenses in a spreadsheet so you can track them.
If you have a good 2-3 years of data then you would be able to determine the average spending and trend and would be able to predict the spend for coming 3 months. This is an important step to ensure that you keep your expenses in check and also not keep overly high balances in your current or savings account.
Avoid Minimum Payment Balance Trap
While optimizing your credit card spending to generate more cash flow for yourself, you need to be careful not to fall into the trap of making minimum payments (however small or big these amounts are).
Below are a few reasons why you should never make minimum payments on your revolving credit:
- You may pay up to 25% APR on the residual balance (outstanding balance minus minimum payment). This is too high by any standards.
- Your credit utilization will start increasing as you make only minimum payments and you will soon start impacting the “% Credit Used” parameter which will lower your credit score.
- Your expenses will start mounting up and with each minimum payment you make, you will be unable to service the outstanding amount. This is likely to spiral out of your control very quickly.
- Your sound financial habits will go for a toss and you will accumulate unsolicited debt at an exorbitant interest rate.
