By Steve Repak, CFP
Special to the Financial Independence Hub
If you are in debt, you have probably heard over and over again that you should quit using credit cards and stick to using cash exclusively for purchases (aka “cash-only” purchases.)
In a previous article I explained that for some people it actually hurts to break a large bill like a $20, so only using cash may help you get your spending under control. I wanted to share some of the risks and benefits of a cash-only lifestyle and also show that you can still get out of debt if you want to use credit cards.
If getting out of debt is your goal, there are three things you must do in order to succeed regardless of whether you use cash or credit:
- Spend less money than you take home each week
- Build an emergency savings
- Develop and follow a get-out-of-debt plan
Cons of using cash
One of the biggest disadvantages of carrying cash is that you can lose it! If you lose your credit card you can cancel it and order a new one but I am afraid you just can’t do that if you lose your cash. If you use an ATM to withdraw cash you may be charged fees, which is like throwing money away. Worse yet, flashing cash can make you a target for thieves.
Benefits of using cash
A great technique for getting your spending under control is by using the envelope method where you have an envelope for each different category of spending. For example you might use an envelope specifically for food expenses such as groceries and eating out, you might have one for clothes, and maybe one for transportation.
I really like the envelope method for your wasteful spending. Yes you read it right, you should have an envelope for your discretionary (fun) spending. It is ok to spend money on things you like or things you like to do but the key is to budget for it just like you do for your savings, rent or mortgage, credit card payments etc. You are only allowed to spend what is in the envelope and not a penny more!
Cons of using credit cards
If you continue to use credit cards and you don’t have your spending under control you will never get out of debt. Even if you do have your spending under control you still may be tempted to use credit cards.
What about balance transfer and introductory (teaser) rates? It may sound enticing to consolidate your credit card debt with a balance transfer offering a low introductory rate but you must read the fine print. For example the 0% promotional rate is just that, it will not last forever. I have seen most offers last anywhere from six to twelve months and then the rate increases, sometimes to a higher rate than you had on your old card. Read the fine print regarding the transfer fees.
There are no free rides and you will be charged a transfer fee. Typical transfer fees are around 3% but they can be much higher so make sure you understand how those fees work before consolidating your debt. Finally, if you do decide to consolidate your debt, do not simply make the minimum payments, or once again you will never get out of debt. The payment to the new card should at a minimum equal the payments you would have been making on the old card(s).
Benefits of using credit cards
You can make credit cards work for you if you are disciplined and plan smartly. For example, there are credit cards where you can earn unlimited cash back on every day purchases, where the cash back doesn’t expire, and there is no limit on how much you can earn. As always make sure you read the fine print, like what your annual credit card fee may be.
My big disclaimer: if you use a credit card with rewards, you must pay the balance in full because it will defeat the purpose of getting rewards if you have to pay interest. Building your credit is another benefit and you can’t build your credit if you use cash. Another advantage of using credit cards over cash are the consumer protections that often come with them, such as limits on fraud losses, rental car insurance, travel insurance and product warranties that may last longer than the original manufacturer’s warranty.
As I mentioned earlier, whether you want to use cash or credit, getting out of debt will only be possible if you spend less money, build your savings and follow a get-out-of-debt plan!
Steve Repak, CFP™ is a Financial Literacy Speaker, author of 6 Week Money Challenge for Your Personal Finances and Dollars & Uncommon Sense: Basic Training for Your Money and a CFP® Board Ambassador. For more information, please visit, www.steverepak.com and connect with him on Twitter, @steverepak.