When to use your financial tools (and when not to)

We have a lot of ‘financial tools’ – like cash or credit cards – available to us, but it’s very important to know when you should use a certain tool, and when you shouldn’t.

Knowing what ‘tools’ work best for different jobs can help save you money, time and stress. It can also help stop you from falling into traps.

Cash

What is it?

We’re going to roll a few items into this one, as many people don’t use physical cash anymore. In this case, it’s any money you already have. That can be actual $20 notes in your purse or wallet or money in your bank or savings account that you access with an EFTPOS or debit card.

When to use it

In general, you can use cash for nearly any transaction. But for clarities sake, these are the priorities you should be putting your cash towards:

• Rent or mortgage payments
• Bills and debt payments
• Small purchases/everyday spending
• Savings
• Investments

Ideally, you want to have around three months or more of expenses saved up in cash, so you can cover any unexpected costs that crop up. Once you have that, you can start thinking of ways to make your money work for you with investments.

When not to use it

There’s no real time not to use cash, but depending on your situation, it can be handy to use another ‘tool’ initially and then use cash to pay it off. Specifically, if you have a rewards credit card, it makes more sense to use it and gain the rewards, then pay off the card in full with the cash you put aside for that purpose.

Credit cards

What is it?

A credit card can be a very powerful tool, when used correctly. It’s essentially a loan limited to a potential pre-defined limit that you can use as much or as little of as you like.

When you use your credit card, you’re borrowing that money to make your purchase. If you pay that money back within a set timeframe, you don’t pay interest. However, if you don’t pay your balance off, you will start to be charged interest.

When to use it

You should use your credit card when you know you’ll have the cash ready to pay your bill off in full when the bill comes in. If you have a rewards card, you should use it instead of cash, but put that cash aside straight away, so you know you’ll be ready to pay. Depending on your card, most purchases (but never cash withdrawals) are interest-free for a certain period of time.

Using your card and paying off the balance in full each month will also help improve your credit score. A higher score means you’re more likely to get lower interest rates, better terms and higher credit limits from lenders for other credit cards or loans, like a mortgage.

It’s important to know your interest-free period and interest rates, so make sure you look over your agreement from time to time.

When not to use it

You should not use a credit card for a big purchase you cannot pay back in full within the interest-free period. This is where understanding your interest-free period (which we cover in-depth in that link) is vitally important. Using your card and not paying the bill means you’ll be charged interest on your balance until the full amount is cleared.

If there is a large purchase that you can’t delay or avoid, you need to use a different financial tool.

Personal Loan

What is it?

A personal loan is a lump sum paid to you by a lender, under the agreement that you’ll pay that amount back to them over a set period of time with interest. Generally, longer the time period, the smaller your regular repayment will be, but you’ll pay a higher amount of interest.

When to use it

Personal loans in particular are a very flexible loan, as there are fewer stipulations on what you can and can’t use it for. It could be used to start a business, do some work on the house, buy tools, purchase a car, etc.

If you have a large purchase to make that can’t wait, and can’t be paid off within your credit card’s interest-free period, then a personal loan could be a good choice. Interest rates on personal loans are usually lower than those of credit cards, and it’ll leave your credit card free to be used for other items you know you can pay off.

When not to use it

When applying, you’ll be shown your interest rate and the regular payment you’ll need to make. If you’re not sure you can always pay that amount each and every time, you should either extend the time period (which will lower the regular cost but increase the total amount you’ll pay), or not take the loan out.

If your circumstances change when you have taken a loan and you’re struggling to make your repayments, contact the lender immediately. They’ll work with you to create a payment plan that works for both of you.

Consolidation Loan

What is it?

This kind of loan is a way to simplify your debt if you have multiple repayments to make. Instead of paying each one separately, the lender pays off your other debts, consolidates them into one loan (usually at a lower rate), and then you repay the one lender at a regular amount over a set period of time.

When to use it

If you have multiple debts that have higher interest rates and you’re struggling to stay on top them, a consolidation loan can be a good answer. Credit card debt can quickly balloon if not paid off, and you lose the main advantage of a credit card if you’re already being charged interest on it.

And having multiple repayments coming out at different times in a month can be difficult to stay on top of, as you may not always have the repayment amount in your account, leading to missed payments or overdraft charges.

When not to use it

If the consolidation loan’s interest rate is higher than the rates of the loans you already have, you probably shouldn’t use it. Instead, you should focus on paying off the debt with the higher interest rate until it’s cleared, then focus on the next one.

You could periodically check and see if the interest rates for a consolidation loan are lower, and when they are, you could use it then.

In summary

Cash is always your starting point for financial tools, but credit cards and loans do have jobs they’re specifically tailored towards:

• Credit cards are good for rewards and improving your credit score if paid off promptly
• Personal loans usually have lower interest rates than credit cards, and are good for large purchases you have to make that can’t wait until you save up, as long as you can meet the repayments
• Consolidation loans can help you take back control over your debt, as well as save you money and stress

This blog is provided for general information purposes and is not a recommendation you enter into or exit any particular loans or insurance policy. Information on the website does not consider your particular circumstances, including your objectives, financial situation or needs. We recommend you seek advice from a financial adviser before taking any action as appropriate. The Lending People Limited (FSP240365) is a licensed financial advice provider and can provide advice on some types of personal loans. Find out more about The Lending People and how we may be able to help you.