This is a guest post written by your friends at Card Hub, a credit card comparison website.
Who’s ready for some spring cleaning? Before you go run and hide, I don’t mean wasting a perfectly good Saturday to clean closets and fill boxes or anything like that.
Instead, I’m talking about the kind of spring cleaning that can help you either pull free from debt or boost the free money you bring in every month.
I’m talking about taking a critical eye to what’s in your wallet in order to compartmentalize your needs and thereby improve the efficiency of your personal finances.
You see, one of the best and most logical credit card strategies is something called the Island Approach. Its overarching message is that you should use different credit cards for different types of transactions, as if they are isolated on separate islands.
In general, this not only enables you to get the best terms for every transaction you wish to make, but it also gives you a clear perspective from which to evaluate your spending habits.
As far as specifics are concerned, let’s start with how the Island Approach will help you save money on and escape from debt.
- It gives you perspective: One of the Island Approach’s basic tenets is that you should use separate credit cards for revolving debt and making everyday purchases. When you have a single credit card, new purchases can blend in with existing debt, making it difficult to determine whether or not you are living within your means. Under a two-card system, however, the presence of finance charges on your everyday spending card will clearly indicate that you are overextending yourself and that you must cut back. This will prevent your debt from worsening and get you in the habit of always paying your routine expenses in full.
- It minimizes the effect of interest: Piggybacking on the above, segmenting your debt and everyday spending allows you to get the best credit card terms for each. You’re not going to find the lowest interest rates and the best rewards on a single credit card, after all, but you can certainly aggregate such terms via two different cards. For example, you could transfer your existing debt to the best 0% balance transfer credit card and use one of the best reward credit cards to maximize the free money you earn every month. What’s more, such a separation lowers your average monthly balance and therefore your interest costs. You see, revolving a balance on a credit card removes your grace period for new purchases, which means that your interest rate will apply to both your debt and whatever you buy. If you designate a credit card as being solely for everyday expenses that you pay for in full, however, you won’t have to worry about interest. Your interest rate will only apply to your revolving debt.
- It manufactures favorable payment allocation: When you have multiple balances on the same credit card, only the payment amount above the required minimum will go to the balance with the highest interest rate. Your most costly debt will therefore last longer than you probably want it to. Separating your balances gives you the power to allocate payments, pay down your debt strategically, and expedite debt freedom.
Ok, but what does the Island Approach do for you when you’re debt free?
It gets you the best terms possible: Once debt free, you can concentrate on maximizing your rewards potential. In order to do so, you should have 2-3 rewards credit cards that provide the best possible returns on your biggest expense categories, thereby complementing each other and giving you the best combination of terms attainable.
For example, if you spend a lot on gas, groceries and travel, a combination of the Discover More Card – which offers up to 20% cash back on every purchase – and the Venture Card from Capital One – which offers what amounts to 2% cash back on all purchases as long as you redeem miles for travel expenses – would prove more beneficial than any single credit card.
You by no means have to adopt the Island Approach, either in part or in full, but you should at least take note of the lessons that it provides and the good habits that it promotes.
After all, many Americans struggle with overleveraging and wasted rewards potential, evidenced by the continued growth of outstanding credit card debt and the fact that over $16 billion in points and miles go unredeemed each year.
[I do not endorse the use of credit cards, unless they can be used responsibly. You should always use discretion when it comes to using credit.]
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