The Dangers of Credit Card Spending in an Economic Downturn
Credit card spending tends to increase during an economic downturn. Here’s why buying things on credit at this time is a bad idea.
Contributing Writer at Tally
September 20, 2022
The number of consumers who are credit card holders hit a record high in the second quarter of 2022, and credit card balances increased by 13%. A lot of this increase is attributed to rising inflation; resorting to credit cards becomes a common theme during an economic downturn or if we get in a tough financial spot.
As finances tighten, U.S. consumers often turn to credit cards to ease the burden and spread their costs out over time. While this may seem logical, it can create even bigger problems down the road.
Below, we outline the dangers of resorting to credit card spending when financial troubles hit and offer ways to keep your credit card spending in check.
Dangers of credit card spending during a rough financial patch
When you’re going through a rough financial patch and struggling to make ends meet, it’s tempting to resort to credit card spending to fill the gaps. Some cardholders may even try to rationalize using credit by pointing out that they can earn cash back and reward points from their credit card issuers.
The biggest issue is that it’s hard to predict just how long a rough financial patch will last, whether it’s the result of a job loss, an economic recession, a lower income, unexpected expenses or rising inflation. So, if you use credit card spending to fill in for what seems like a small $100 monthly deficit but the downturn lasts 12 months, you’ve incurred $1,200 in high-interest credit card debt.
The average credit card interest rate is 16.45%, so you’d pay roughly $197 per year in interest on a balance of $1,200. And if you pay only the minimum monthly payment on each bill, that means it could take you over 10 years to repay that $1,200 — and cost you over $1,100 in interest.
As for those credit card rewards, they often don’t give back enough to make it worthwhile. Some of the best rewards credit card accounts offer 1.5% cash back, meaning you’d earn $18 in rewards from that $1,200 in credit card spending, but you’d still be losing well over $1,000 in interest charges to the credit card company if you pay off that debt by only making the minimum payments.
Long-term effects of large credit card balances
Though it may seem like immediate relief, adding credit card spending to the mix can significantly extend your rough financial patch.
On top of the financial hit of paying interest, racking up credit card balances can also hurt your credit score for years. As you increase your credit card spending, your credit utilization ratio — your total credit card balances relative to your total credit limits — will increase. The higher this ratio, the more negatively it impacts the amount of debt factored into your FICO credit score calculation. The amount of debt factor accounts for 30% of your FICO credit score, so a rising utilization rate can significantly impact your financial status.
Without a good credit score, you may get charged higher interest rates on loans and mortgages. And if your credit score falls enough, you may be denied loans outright. Also, your credit score can impact your ability to secure insurance, rent a home and even get utilities, like gas, electricity and water, put into your name.
If your financial situation worsens to the point where you struggle to make your minimum payment each month, you could end up with late fees or missed payments and delinquency. The latter two can cause serious negative marks on your credit report and significantly lower your credit score.
How to avoid credit card spending during a rough financial patch
When an economic downturn tosses you into financial turmoil, don’t resort to credit card spending and turn a short-term financial issue into years of credit card payments. The following four alternatives can help you get through a rough financial patch without making excessive credit card purchases.
1. Trim your budget
When financial difficulty looms, the first thing to do is review your budget and find places where you can trim without significantly impacting your quality of life. This can include dropping to a lower-cost cellular service package, cutting a streaming service or subscription you rarely use or finding a lower-cost car insurance plan.
You can change your spending habits. If you like to stop by the coffee shop every day for a $3 cup of coffee, you can switch to making your own at home for 27 cents per cup. If you do this every day, you’ll save nearly $1,000 per year: $19.11 per week, $82.81 per month, $993.72 per year.
These small adjustments may seem insignificant on their own. However, if you find multiple places to trim, you can free up some significant cash each month.
2. Take on a side hustle
In today’s gig economy, getting a side job that you can work at your convenience is easier than ever. Whether it’s food or grocery deliveries, ride-sharing, task completion or freelancing, these on-demand jobs can give you the cash you need to get through a rough financial patch without using credit cards.
The best part is that you can step away from the side gig at any time once you're through the rough patch.
3. Create emergency and rainy day funds ahead of time
Building healthy savings is a great way to mitigate a rough financial patch. It’s ideal to have two types of savings.
The first is an emergency fund with enough cash to cover three to six months of living expenses. The second is a rainy day fund. This is a smaller fund, generally around $1,000, to take care of unexpected expenses. You can use it for home or car repairs, replace an appliance if it breaks and cover other problems that could pop up and cause a financial burden.
Place the emergency and rainy day cash in high-yield savings accounts until you need them so they gain interest and grow while sitting idle.
4. Leave the credit card at home
Another way to keep your credit card spending in check is to make your credit card inaccessible when you go shopping. Instead of keeping it in your wallet or purse, leave it at home in a locked drawer or give it to a trusted friend or family member for safekeeping. This will force you to pay with either cash or a debit card instead of resorting to consumer credit card spending.
Resist credit card spending in an economic downturn
While it may seem convenient now to resort to credit card spending when finances get tight, this can end up turning a short-term bump in the road into long-term debt. Instead, prepare for these instances by building emergency and rainy day funds. If you find yourself already in this situation, trim your budget or take on a side gig to help you wade through the economic downturn and come out debt-free on the other side.
If you’re struggling with credit card debt and making your minimum payments is becoming difficult, the Tally†credit card debt repayment app can help. The Tally app helps you manage your monthly credit card payments, and Tally also offers a lower-interest personal line of credit you can use to efficiently pay off higher-interest credit cards.
†To get the benefits of a Tally line of credit, you must qualify for and accept a Tally line of credit. The APR (which is the same as your interest rate) will be between 7.90% and 29.99% per year and will be based on your credit history. The APR will vary with the market based on the Prime Rate. Annual fees range from $0 to $300.