4 Alternatives to Using a Credit Card for Big Purchases
The millennial generation, on the whole, seems to shy away from using credit cards. The Great Recession and mounting student loan debt have apparently soured millennials on plastic. Compared to their elders over 30, almost twice as many consumers in their 20s don't have a single credit card. A recent study of credit trends found the number of millennials without cards had doubled in five years.
Still, young people who do favor cards often look for new and creative ways to use them. But if you're one for them -- take the advice of a veteran credit card debtor and be cautious. The following are examples of millennials using a credit card in the wrong way.
1. College tuition
In many cases, a decision to pay your school tuition with your credit card is made for you. At many schools, tuition cannot be paid with a credit card. However, schools that accept credit cards also charge a fee. The fees vary, usually from 1 to 3 percent, and average 2.62 percent, in a survey of 300 schools. The fees just add insult to injury. If it doesn't make sense to pay your tuition with high interest rates by using a credit card -- it makes even less sense to pay that interest along with an additional fee from your school for the privilege of using a credit card.
At very few schools, tuition can be paid with a credit card with no fee. This is about the only circumstance in which you'd want to charge tuition to a credit card, and that's if you can pay the balance off in full. Otherwise, you'd be adding to your debt interest and finance charges, which are unfortunately much more expensive than those on student loans. And any credit card incentives in points or miles you might earn would be canceled out by those fees.
Alternative: Before the new semester or quarter starts, apply for financial aid and be sure to see what kinds of scholarships are offered. Even if you have to get a student loan, the interest on it will be less than what credit cards charge.
2. Income taxes
This is another expensive proposition. The IRS requires the use of designated vendors if you want to use your credit card to pay taxes. The lowest fee we could find among them was 1.87 percent of your payment. That means an $8,000 tax bill would likely cost you upwards of $150 upfront to pay by credit card. On top of that, you pay your card interest on the balance. But you can deduct the convenience fee on next year's tax return.
Being a little more practical, you might compare the costs of paying by credit card with the costs of seeking an installment payment agreement with the IRS. Typically, taxpayers get five years to pay off debt, and if you owe $25,000 or less, you could set your monthly payment amount as long as the balance is paid off in 60 months.
But you'd still have to pay interest and late penalties. If you failed to file on time, the IRS would charge 5 percent of the amount owed for each month that your return is late up to five months. There'd also be a setup fee and, of course, compounded interest.
Alternative: As mentioned above, you can look into an installment plan with the IRS, but be aware of the interest. A better plan is to put away money each month if you know you will probably owe money, come tax season. Set an automatic payment from your checking to go directly into a high-interest savings account each month.
If you're a millennial who's managed to purchase a house, this is probably your biggest debt. Paying your mortgage with your credit card would probably cost more than any credit card rewards you would receive. You can find third-party services that will let you pay your mortgage using a credit card. But, the fees they charge are somewhere in the 2.5 to 3 percent range. That’s going to more than offset any potential benefit from earned rewards.
Obviously, if their fee is 3 percent of your mortgage and your credit card pays 1.5 percent cash back, you be losing money by paying this way. However, if you have a credit card that applies your cash back benefit to the mortgage principal, it might be something to calculate and consider.
Alternative: Consider making an extra mortgage payment each year to pay down your debt, so rather than 12 payments a year, make 13. Of course you need to check with your lender to make sure you won't be charged a penalty for doing this.
4. Car and other big ticket items
At first glance using a credit card for this kind of spending makes more sense than what we've seen so far. That is if you can get a zero interest card offer for at least 18 months with a $10,000 or higher balance. If you're sure you can pay off the balance within the monthly term limit, it could work. But there are still concerns about a deal like this.
With a car, if you charge all or part of your down payment, you have little, or no cash invested. That means that you've financed close to 100 percent. So when you drive a new car off the lot, and the value drops 20 percent, you already owe more than the car is worth.
Also, most auto insurance covers accidents up to the amount of the car's actual value. That means if you were to have a total loss, your insurance would still leave you to pay the out-of-pocket difference between what you owe and what the car is worth.
If you buy gap insurance (to cover the gap between what you owe and what the car is worth), you have to maintain that coverage until the car is worth less than you owe. That's cash you could have either saved for the down payment or used to pay off that credit card bill.
Any time you put a large amount on plastic and don't pay it off right away, your credit score can take a hit. That's because the FICO score calculates how much credit you have available against the amount of credit you're using. The higher the percentage, the lower your score.
So, ironically, in trying to exploit the value of your credit in this way, you may cause the devaluation of your credit.
Alternative: For big purchases, it's best to save the good old fashioned way. Instead of using your plastic, give yourself a weekly allowance by creating a budget. Allocate spending money, set aside what you need for bills, and move a set amount to your savings account.If you have a problem of making spontaneous purchases and are unable to resist the temptations of a credit card, try instead leaving it at home and use your debit card or cash.