Every time I explain the credit card float to people, I feel like I’m breaking bad news to them. It’s not fun, but it is an important concept to understand, so I’m going to take some time here and explain it.
When you charge on a credit card, you’re given a grace period to pay things off. It’s usually around 25 days. As long as you pay it in full within that time frame, you are not charged interest. Many people take advantage of this. They charge this month, then pay it off next month.
First, let’s be clear: That’s debt. It’s debt from the second you charge on the card.
It’s like a library book. If I go to the library and borrow a book, they’ll say, “No problem, take the book! Just make sure you get it back to us in two weeks.” I have to return it. It’s not my book. Even if I plan to bring it back tomorrow, that doesn’t make it my book today. I may have possession, but that doesn’t give me ownership: there’s a difference.
Keep that in mind. Now, let’s step back for a second and talk about what YNAB recommends when it comes to cash flow.
We teach people to live on the money they made last month, so they’re a month ahead. (Rule Four) That’s the goal. That’s nirvana. It works like this: Money comes in, then you budget those dollars. Then you spend, letting the budget guide your spending decisions.
People who are riding the float are doing those things in the wrong order. They spend, wait for money to come in, then budget to cover the spending.
Let’s walk through it. Follow me through time. It’s January. You charge everything on your credit card. Bills, groceries, gas, everything. You’re not worried because you’re going to pay the whole thing off next month.
Then you get paid in February and the bill comes. Sweet! You can pay it! Here’s the catch. Right when you pay off that credit card (with all of last month’s spending on it), it’s now time to buy more stuff!
People who pay the credit card balance in full often can’t cover the current month’s spending. So what do they do? They charge all the spending on the card and pay it next month. Do you see the cycle? It perpetuates itself. You’re trapped a month behind.
Still not sure if this applies to you? Here’s the test to determine if you are trapped in the float: If you can’t pay the credit card in full right now AND meet your current obligations, you’ve got debt. You’ve probably been riding the float.
If you’ve been riding the float and then decide to try YNAB, you get a huge wake up call. YNAB is like that really honest best friend. You know what I mean–the one who tells you the truth even when you don’t want to hear it.
YNAB wants you to create a budget with money you have. So YNAB sees this credit card debt and puts it in your face, saying, “Hold on there, Cowboy! You only have enough money to pay off the credit card OR budget for this month’s expenses. You can’t do both!”
If you pay off the spending from last month on the credit card, you’ll have nothing to budget with this month. If you use the money to budget this month, you can’t pay off the whole balance on the card.
You may be thinking, “How did this happen?!? It’s not fair! I was being so responsible! I paid it off every month.” It happened because every time you charged on that card, you promised away future income.
So what to do?
1: Acknowledge that this is debt.
2: Make a decision. Do you want to break the cycle quickly or slowly?
If you want to break it quickly, stop paying the card in full. It’s painful, I know. But it will allow you to budget for your current obligations. You’ll gain powerful awareness when you start connecting the money you have to a concrete plan. You can still budget to pay off that balance a little bit each month.
If you want to break it slowly and continue paying it in full, cut back on all unnecessary spending. Slash wherever you can for a while. Stop using the card unless you absolutely have to. You’re going to see a lot of overspending in YNAB, so budget to cover it as soon as you get money.
Remember, you don’t own the money that you borrow despite the fact that it is in your possession. It’s a loan. Work as quickly as you can to pay it back and get to a point of true ownership. At that point, you’ll have moved from living on next month’s income to living on last month’s income.
I want to be clear–I’m not against taking advantage of the grace period on a credit card. I just don’t want you in a vulnerable position where paying that debt depends on future income. Always remember: the future income is not here yet and is not guaranteed, but the debt is here right now–that’s a sure thing!
Once you’re living on last month’s income, you can use that credit card to your heart’s content because you’ll be budgeting with money that you already own, and you’ll know you can pay that bill anytime you want. That’s freedom. That’s peace of mind.
That’s where YNAB wants to take you.