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4:38 AM Wed, Nov. 21st

Practical Saver: Reward points encourage overspending, sabotage debt reduction

Years ago, Ross and I embarked on a mission to get out of debt. We had accumulated $7,000 in credit card debt. I was profoundly puzzled because we are not impulse shoppers; we don't get carried away shopping, and luxury purchases are planned far in advance. I eventually discovered that small, intermittent, yet sometimes necessary purchases were the cause of our grief. Take the tires for our Suburban. We had saved enough for three tires, but naturally we needed four. We had saved to fly to Iowa, but we hadn't saved enough for the rental car. With situations like these, the credit card balance grew a little at a time.

When credit card debt creeps up, a debt reduction strategy is necessary. This is a great testimony to having a solid spending plan is established. If $100 is added each month to a credit card with a 14 percent interest rate, and ONLY the minimum monthly payment is made, at the end of five years the credit card balance will be $4,390. If left unchecked, that balance will grow to $6,885 at the end of ten years.

An important strategy is to avoid credit card fees. Late fees can strangle the momentum of paying down debt. In 2009, according to the Consumer Action credit card survey, the average late fee was $28. To avoid late fees, the minimum payment needs to be made on time. Most companies will allow cardholders set up automatic payments, which will ensure no late fees. In fact, credit card companies allow cardholders to assign either a set payment amount to be paid or have the minimum payment automatically paid each month. Keep in mind, while requesting that the minimum payment be made is an effective strategy to prevent late fees, it is absolutely not a rapid method to pay off a card. If a minimum payment is scheduled, it is important to manually make another payment in order to insure that the card balance is reduced in a timely manner.

On another note, the temptation of credit card reward points must be resisted. Reward points can usually be redeemed for gift cards, merchandise, and travel discounts. Consumers love reward points. According to CreditCards.com, consumers say rewards are the second-most important reason for choosing a specific card, behind no annual fees, but ahead of low interest rates. I often see this misled excitement in my readers. When I hear, "I earned $500 in gift cards with my reward points," or "I earned a free airline ticket from my points," I have to wonder: How much did these points really cost?

Using reward points as a motivator to use a credit card can have major pitfalls. When credit cards are used instead of cash for daily spending, studies show that consumers overspend by 33 percent. With this formula, if a consumer charged $1,000 per month of daily purchases (such as groceries, entertainment, and clothing) he would potentially earn 1,000 reward points. If this spending continued for a year, the purchases would reach $12,000, and potentially earn 12,000 reward points. Although point redemption varies from company to company, these 12,000 points will probably score a $100 gift card.

Now, look at a contrasting approach. If shoppers used cash instead of a credit card for those same daily purchases, statistically, they would have only spent $750 and not $1,000 (approximately 33 percent less). Now, the total annual cash outlay would only be $9,000. This formula of credit card overspending shows that the "carrot" of reward point gift cards doesn't add up. It doesn't take a financial planner to calculate that a $3,000 cash savings is much better than a $100 gift card.

I fully understand that debt balances can creep up on us when we are not paying attention. We can win the battle when we strategize to avoid late fees and do not be tempted by offers to encourage overspending. It is our job to manage our money - it's best to keep the credit card companies out of our business!

Kara Rozendaal, a financial planner, wife and homeschool mother of three, has lived in Prescott Valley for 15 years. Learn more about coupon classes and ways to save money at her website, www.PracticalSaver.com.