The holiday spending season can put a sizable dent in even the strictest of budgets. Unless you have enough cash on hand to handle your holiday gift list (an unlikely scenario given the nation's current record-breaking level of consumer debt), chances are you'll need to opt for an alternative form of payment.
The question becomes, what is the best way to manage your holiday expenses without crippling your credit score? Before you take out a payday loan or start swiping your credit card, it's important that you consider the repercussions.
The problem with plastic
Credit cards are often the easiest and most convenient way to pay for purchases during the holiday crush. Unfortunately, placing all of your purchases on credit could get you into serious trouble if you don't pay it back on time, and in full.
That's not to say that you shouldn't ever use your credit card for holiday shopping. Lots of online retailers offer exclusive web deals to shoppers, which can ultimately save you a ton of cash in the long run. However, you need to be smart when it comes to racking up credit card debt. If you're going to put something on your credit card, make sure that you can pay back the whole sum by the end of the month (or your statement due date). Paying nothing but the minimum balance on your credit card after the holiday rush will cause your debt to snowball thanks to compound interest.
For example, let's say you put $5,000.00 on your credit card this holiday season (seems like a lot, but with gifts, entertaining, maybe a little ski trip thrown in…it adds up). If the interest rate on your card is charged at 15.99 annual percentage rate (APR), and you pay only the minimum monthly payment ($110 to start), it will take you 25 years to pay off your holiday purchases. During this time, you'll pay roughly $7,006.00 in interest, for a total payment of $12,006.00. Paying just $25.00 on top of the required minimum would reduce your total payments by $3,758.00. Your total interest paid would also be cut by more than half to $3,248.00.
The moral of the story? If you can't pay off your balance quickly, don't put it on your credit card. Period.
Is a credit card cash advance a better option?
Most credit card companies allow their customers to take out cash on credit through an ATM or a bank withdrawal. This sounds very similar to a debit card withdrawal, except for one big difference: your initial fee for a credit card cash advance could be as high as 3 or 5 percent. What's more, the amount you took out starts accruing interest immediately (versus when you charge something to your credit card wherein you have a window to pay it off before interest is charged) and often at a higher rate than your normal credit card interest fee.
Let's look at our original example. Assume that, instead of charging the $5,000.00 to your credit card, you took the cash out as an advance on your credit card account. If the cash advance fee is 4 percent, you're looking at a charge of $200.00. You'll also be hit with an ATM charge of roughly $2.00 if you made the withdrawal at an ATM that's not associated with your card (admittedly, nominal compared to the $200!). Finally, don't forget that your cash advance has no grace period when it comes to accrued interest AND this accrued interest rolls over every two weeks (rather than monthly). This means that you'll be charged $600.00 (or more if the interest is compounded!) of interest in a six-week period. Ouch.
Don't even think about a payday loan
There's a reason payday loans have been nicknamed "predatory" loans by financial advisors. They're so bad in fact, that the State of New York has made them illegal. Defined as a relatively small (usually under $500) high interest, short-term loan, payday agreements provide the borrower with cash, minus a lenders fee.
What most borrowers don't understand is that most of these loans have extremely short payback periods (often just two weeks) and astronomically high APR rates (some are as high as 420 percent!).
So, that $5,000.00 you needed to buy holiday gifts with? Let's assume you write a personal cheque to the payday lender for $5,045.00 (the $5,000.00 plus a $45.00 fee). The lender then provides you with the $5,000.00 in cash and agrees to hold your check for two weeks. When that date arrives, the lender either cashes the cheque, or offers to roll your payment over for another two weeks — for another $45.00, of course. Fail to pay back your original amount after six weeks and you're looking at $135.00 in additional charges.
Let your receipt tell the truth
At the end of the day, cold, hard cash (the kind that's 100 percent yours) is the best way to finance your holiday shopping needs. In this way, what your gifts are really costing you is exactly what it says on the receipt.
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Nothing contained herein is intended to provide personalized financial, legal or tax advice. Before implementing any financial or legal strategy, you should obtain information and advice from your financial, legal and/or tax advisers who are fully aware of your individual circumstances, as well as fully aware of current laws and regulations.