There’s no doubt about it: Avoiding credit card debt is a smart financial move. But have you ever stopped to consider exactly why credit card debt is so bad? As it turns out, it can lead to consequences a lot more serious than just big interest payments.
Here are 5 ways credit card debt could wreck your finances — consider yourself warned!
1. Above all, there’s a huge opportunity cost to paying all that interest
Yes, credit cards generally charge double-digit APRs and carrying a balance from month to month will result in big bucks washed down the drain on interest payments. But it’s not just this wasted money that’s bad news for your financial picture – it’s also the opportunity cost of shelling out all that cash.
For instance, if you’re paying hundreds in interest on your credit card debt every year, then you’re not using that cash to pay for a class that will increase your earning potential. You’re not using those hundreds as seed money to start a business. Heck, you’re not using the money to taking a needed vacation that will prevent burnout at work. So it’s more than just the money that you’re paying in interest, per se – credit card debt interferes with your ability to put your money to better use.
Looking for more specific examples of this? Read on.
2. Huge payments could make it hard to save for emergencies
Building up a reserve fund of 3-6 months of living expenses is a good way to protect yourself from the financial fallout of life’s inevitable emergencies. But for most people, 3-6 months of expenses represents several thousand in cash, and saving it up takes time even under the best circumstances.
If you’re making huge payments on a pile of credit card debt, you’re not going to be able to devote much of your monthly pay to emergency savings. This could leave you vulnerable to serious financial strain if a large, unexpected expense arises. Looked at through this lens, it’s easy to see how credit card debt really jeopardizes your future financial stability.
3. You’ll be discouraged from investing
When there’s a choice to be made between paying down credit card debt and investing, most people choose paying down debt. This is undoubtedly a reasonable choice. After all, market returns aren’t guaranteed. But the double-digit savings on interest you’ll see if you eliminate your credit card debt is.
However, the longer you delay investing as you toss your excess cash at your credit card balance, the harder it’s going to be to build a big enough nest egg to retire. Since most people don’t have employer-sponsored pension plans these days, our own funds are all we’ve got. You could be facing a serious financial crisis in your golden years if you let credit card debt slow down your wealth-building today.
4. It could hurt your credit, which makes all other loans more expensive
A factor that heavily influences the 30% of your FICO score that’s determined by “amounts owed” is a number known as your credit utilization ratio. This is the total amount you owe on your credit cards compared with your credit limit. If your credit card debt is pushing your credit utilization ratio above 30%, you should expect your score to suffer.
The problem here is that a low FICO score will cause any new loans that you take out to carry a higher interest rate. Consequently, your monthly payments will be higher, and this further cuts into your ability to use your income for saving and investing.
In short, credit card debt is a double-whammy: It’s expensive on its own, but it causes other products to become costlier, too. Shelling out so much cash every month makes getting to a financially comfortable place hard for most folks.
5. If you end up in bankruptcy, your earning potential might be limited
It’s not uncommon for employers to check potential employees’ credit reports before extending a job offer. If you end up filing for bankruptcy because of credit card debt and your boss sees this during a routine background check, there’s the possibility the promotion you’re after could go to someone else.
Although indirect, by interfering with your employability, a past credit card debt disaster could hurt your earning potential. So hopefully it’s clear – from this example and the others above – that getting in over your head with credit cards is bad news for reasons way beyond just big interest payments. If you don’t make an effort to pay off your debt now, your financial future could be at stake.
Wrecking ball image via Shutterstock
The post 5 Ways Credit Card Debt Could Wreck Your Finances appeared first on NerdWallet Credit Card Blog.
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