Credit cards can be a convenient financial management tool, but they can also be a way to get into deep financial trouble. With their high interest rates and convenience, it's easy to run up a substantial amount of debt.
Even if you think you're handling your credit card debt properly, you could still be a victim of credit card float. Here's how to determine if you're trapped in credit card float and how to get out of it.
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What Is Credit Card Float?
Quite simply, credit card float is using next month's income to pay for this month's expenses. Here's how it works.
At the beginning of the month, you use your credit card to pay for everyday expenses such as gas, groceries, utility bills, lunches, dry cleaners and eating dinners out. When you get paid the next month, you take a big chunk out of your paycheck and pay off the outstanding balance on your credit card before the due date and within the grace period.
Everything looks fine. You paid your credit card account balance before the due date, so you haven't incurred any interest charges or bank fees. Your credit card utilization of your total line of credit is low, and your credit report shows a good credit score.
The problem is you're always a month behind in paying your everyday expenses. At some point, you begin to realize that you're repeating the same thing over and over, and you don't have a way to get out of the cycle.
If you're using your credit card to pay for this month's expenses and paying it off with next month's income, you're a victim of credit card float.
Always Playing Catch-Up With Expenses
If you can't pay your entire credit card bill right now and meet all your other expenses, then you're on the credit card float cycle. If the balance in your checking account is lower than the amount owed on your credit card, then you're on credit card float.
Even if you can pay off your credit card balance in full every month, you may still be riding the float. If you don't have enough money in your bank account to pay for your everyday expenses as you go through the week, you're on the credit card float.
Every time you make a charge on your credit card because you don't have the money to pay for it, you're going into debt and living on future income. And that's the problem
Credit Card Float Is Debt
When you use a credit card to pay for expenses, that's debt. You are borrowing money from someone else to pay for today's expenses.
The problem with credit card float is that your monthly cash income isn't enough to pay your current expenses, and you're always a month behind. Even though your credit score isn't affected by credit card float because you're always paying off the balance, you're nevertheless still running behind on your monthly cash flow.
You may feel that your personal finances are in good shape, but when you're borrowing money because you don't have enough in your account to pay your expenses, you're not in the best financial health. It means you're running your household expenses at a cash flow deficit each month.
Eliminate Credit Card Float
The only way to get out of the credit card float cycle is to either reduce expenses or increase your income. Unless you've got a side gig ready to go, you'll get the most immediate results by reducing your expenses.
The first step is to analyze your expenses and find out where your money is going. Add up all your expenses, including rent or mortgage payments, utilities, student loans, auto loans and all other everyday expenses.
Then look at each expense item and see if they can either be eliminated or reduced. The amount that you can reduce your monthly expenses is the amount that you'll be able to reduce your credit card usage each month.
Ending Credit Card Float
Let's take an example. Suppose your net monthly income is $5,000, your monthly expenses add up to $5,000 and you've been charging $1,900 of everyday expenses to your credit card each month.
After analyzing your expenses, you have determined that you can reduce your overall monthly expenses by 2 percent, or $100 ($5,000 times 2 percent). That's the amount you can use to start reducing the amount of your credit card charges each month.
Starting the next month, you would only charge $1,800 to your credit card, and the month after that, you would charge $1,700. At that rate, it'll take 19 months ($1,900/$100) to reduce your credit card float to zero. As you can see, it's not a quick fix, but it's a sure-fire way to get ahead of the game and get out of the credit card float cycle.
If you stick with your new budget with the reduced expenses, you should start to realize a positive cash flow and be able to put more funds aside for emergency funds or savings accounts. Now you can reach for your debit card instead of your credit card to pay for your monthly expenses.
Risks of Credit Card Debt
Every household needs some way to deal with emergency financial expenses that occur with amazing regularity. It could be a bank savings account with funds set aside to cover unexpected expenses, or it could be having availability on your credit cards to draw down in case of an emergency.
However, if you're in the cycle of using credit card float, you would have less availability under your credit card line of credit, and this could put you at financial risk.
What About Using Rewards Cards?
Getting out of the credit card float cycle doesn't mean that you shouldn't use credit cards to earn the rewards points that some credit card companies offer as incentives to use their cards. However, you should probably adopt the tactic of using your credit card and paying off the balance at the end of each week instead of waiting until the end of the billing cycle to pay the entire balance in full.
Take your Netflix subscription as an example. Suppose your payday is on the 15th of each month, and your Netflix subscription is due on the 18th. You can use your credit card to pay the Netflix subscription, and then pay it off at the end of the week since the money is already in your account and allocated in your budget for that purpose.
Another typical example is groceries. Suppose you budgeted $200 per week for groceries and in one week you spent $150. You can put this charge on your credit card, earn the rewards points and then pay it off right away because the money is already in your account. At this point, you should have enough funds in your checking account to make a credit card payment at any time without creating an overdraft and still have a comfortable reserve balance in your account.
Being able to eliminate credit card float and having enough money in your bank account to pay your credit card balance at any time eliminates the feeling of always being behind and having to run to catch up.