Americans have a love-hate relationship with credit cards. That’s because using credit isn’t seen as using real money.
Most folks have a vague awareness of creditors “out there” until the monthly bills roll in. Especially after major holidays like Christmas or vacations. Buying gifts or trips without cash may yield some terrific bargains and fun. So what can the average consumer do to ease the burden?
We’ll always have credit card debt
We Americans will always have credit card debt. It’s way too easy to whip out your plastic and make an impulse buy for something you’d think twice about if you were laying down cash. So how did this line of thinking come about?
We’ve been conditioned from our teen years. Credit card issuers aren’t dumb. They know that if they dangle mail offers to increase your credit limits or transfer balances for lower interest rate cards, folks will go for it. This is business based on solid psychology: If they make it easy for you to borrow more, you will.
Stats tell the story
In 2015, the Federal Reserve released revolving credit card debt data. This came to a whopping $935.6 billion. That’s $15,762 for every U.S. household. The average debt was $4,717 for every credit card junky with average interest rates at 15%.
Why does credit card debt use remain unchanged by economic swings?
The biggest reason is that credit is too easy to get and folks just can’t seem to say no when offered credit. I can testify to this.
When I worked in an electronics super store, several customers took great pride in showing me their wallets stuffed with credit cards. Worse yet, when these folks made purchases, they often had to slap a 200-$300 buy spread over several cards cause most of the credit cards they had were maxed out.
Are you a revolver or a deadbeat?
Credit card junkies fall into two groups: convenience user and revolvers.
Convenience users are the minority who pay off their bill every month. For these folks, credit cards are a convenience, sometimes earning bonus points and rewards. They don’t feel compelled to borrow.
These are the same folks who some credit card issuers describe as “deadbeats” because they use the issuers’ cards to make purchases and pay them off before any interest charges accumulate. Awww, gee!
The second group are the “revolvers” who don’t pay off their bills in full every month, so the debt revolves or rolls over into the next monthly cycle, along with interest and other charges.
The Minimum Payment Trap
Every credit card statement has a chart that shows how your credit card minimum payment is calculated. It requires credit card issuers to show you how long it will take to pay off a card by paying only the minimum payment.
Before 2004, these minimums averaged just 2 percent, which meant that you owed your soul to the credit card store because large balances would take decades to pay down. Again this is a basic business principle: most folks prefer to pay only the minimum because it’s “cheaper.”
But in 2009 the Fed passed The Credit Card Accountability, Responsibility and Disclosure Act. This bill increased required minimum credit card payments.
How minimum payments are calculated today
Today minimums are calculated in two ways. One is 3-5% of the total balance due. The other includes all fees and interest due for a month, plus 1 % of the principal amount owed. Paying just the minimums will quickly put you into a negative cash flow situation.
Before any payments are credited, interest accrues on both old and new purchases, late, over limit and past cash advance fees. Payment minimums are factored by taking the card balance or principal, adding in any any new and old charges you made, plus adding interest, all divided by 1/12, yielding 1.5% interest per month, or 18% APR (Annual Percentage Rate).
Use this debt-free calculator to see how long it will take to pay off your credit cards
Risky ways to pay off credit card debt
Most reducing consumer credit card debt plans require you to pay the minimums on all your cards and attack one with the highest balance or the highest interest rate first.
Here’s a summary of those plans. They usually fail because they also require the “D” word. More on this later.
Pay just the minimum
This is the slowest way to get there and incredibly expensive. Sometimes some card issuers list a minimum payment that is actually less than accrued interest, guaranteeing that the card balance will increase automatically.
Use your retirement savings
Not a good idea. You’re risking financial security in the future for short term relief now. Not to mention that the IRS can hit you for taxes on money withdrawn before a date that you’ve agreed to. And the financial institution controlling your retirement account may levy penalties of up to 25%.
Rob emergency funds
This also is a big no-no. Using your emergency funds will leave you and your family vulnerable until you can replace money used. Emergencies come in all shapes and sizes like medical, natural disaster, job loss or accident. All are expensive to deal with.
Tap into home equity
This technique destroys the buffer zone you placed between default and foreclosure should you experience a calamity of some sort.
Skip mortgage payments
This is a dumb way of robbing Peter to pay Paul. Trouble is, Peter won’t like it. If you like to gamble, hit the craps tables in Vegas instead.
Get another loan
Keep in mind that the easiest loans to get are usually the most costly like payday loans
Payday loans are made by predatory lenders to capture the unwary and drain their victims dry. They promise the moon and charge you for the ride with interest rates of up to 400%+.
Neighborhood bank or credit union signature loans are possible but you gotta qualify. Even then the loan approved may not be enough to get you completely out from under, since they range from $5,000 to $15,000.
Good strategies to reduce or eliminate credit card debt
All of these techniques require paying the minimum balances on time to avoid incurring late charges. All remain locked into the “B” word – budget.
No matter which plan you choose to do, once you’re chosen, stick to your plan.
If you haven’t used a budget previously, now’s the time to start. A written plan is hard to ignore or “forget” when your’re eager to slap down a card for that “must-have” deal.
Your budget will show how much money you’ll need and how much you have to use for knocking down credit card balances. Once you establish this, stay with it no matter what. I didn’t say it would be easy. It won’t. Getting debt free as a credit card junky is rarely easy but really rewarding
Crunch the numbers
A focused approach on one small balance credit card is better than attacking every card at once. Even small amounts will reduce debt by chipping away at the principle, reducing interest and decrease repayment time. Working your payment schedule can reduce your repayment time by up to 50% or more, depending on how much you designate that second payment will be.
Debt reduction ain’t easy
It takes discipline. Payments must be mailed or sent electronically on time no matter what. And you must continue to pay the minimum balance on all your other credit cards.
Snail mail with the USPS is subject to processing delays of up to five days. And yes, creditors play the delay game, claiming that your payments didn’t arrive before your due date, instantly incurring a whopper late charge of $25-$35. So send it out 10 days in advance of the due date.
Online bill paying is much more reliable because it gives you tighter control. You can schedule payments at least a week before the due date to insure that payments arrive 2-3 days ahead of the due date. But this sin’t infallible either. Make sure to monitor your account to see if the payments actually go out. And remember that this system shuts down on weekends and holidays.
Attack the card with the highest interest rate
While this is an OK approach, it’s slow with little immediate psychological payoff. If you’re one of those folks buried under a ton of revolving credit card debt and living paycheck-to-paycheck hoping nothing bad will happen, you can become overwhelmed by how slow this process can be.
Target the card with the smallest balance
This method has the greatest psychological boost.
Once you’ve paid the designated second payment on the card, you can watch your balance begin to dwindle until the card balance is history. Then roll over your extra cash and apply it to the next credit card with the second smallest balance. After that card is gone, go on to another. This works because we like to accomplish short-term goals that yield results right away.
But beware. Some credit cards’ minimum payments are less than their finance charge. So if you pay only the minimums, you’re still getting hit with interest and the minimums just won’t cut it.
The Payment Pushback
Once you decide which card to attack, you need to plan on specified dates to get the biggest debt reduction benefits.
It’s pretty simple. First figure the due dates of your card’s minimum payment. Then make a chart for a second payment scheduled 10-14 days after this due date.
This method works by reducing the principal and interest charged. Most credit card issuers use a formula that adds purchases and interest before deducting any payments made. Paying minimum balances has the same effect as a mosquito hitting an 18-wheeler. But when you send a second scheduled payment 2 weeks after the due date, it becomes your Big Rig and the credit card issuer the mosquito. Just paying an additional half payment every two weeks yields an additional 13 payments for the year, applied to principal before interest charges can accrue.
5 Ways to ease your pain while reducing credit card debt
Stop buying and make your minimum payments on time
Stop! It’s time to bite the bullet and control those impulse buys. Set a goal to resume buying once you’ve knocked out a card or two or paid off everything. This isn’t easy. Emergencies can and do appear. Designate one card to use when the unforseens come. But charge nothing else on this card.
Your statement will shows a minimum monthly payment for you to make. While you concentrate on aggressively attacking your target card, continue to make this same minimum payment while you’re in the trenches.
This will help you to get debt free faster. The payoff is that as your balance shrinks, you pay more than the current minimum automatically and you can watch your balance rapidly shrink.
Get Level Pay Plans for your utility bills
A utility Level Pay Plans is one of the better debt reduction weapons. Utilities will calculate for you what your Level Plan bill will be based a total use for the previous year. This amount is divided by 12 to get your monthly rate. Pay these amounts on a set day every month.
Using a level pay plan makes it easy to handle utility payments like electricity for the hot summer months and natural gas for the cold ones. But a word of warning: don’t forget to pay these payments or pay late. If you do, the utility may cancel your plan and you’d be back to square one and liable for the entire bill for any particular month.
Maintain a spreadsheet of all of your active credit accounts, including balances, interest rates and payment due dates. When you close an account you’ll be able to see on your spreadsheet that the account is history. A little visual reinforcement is a good thing.
And if you fall into temptation, the spreadsheet will also show you how much longer it will take to achieve your goal because of the added balance of an impulse buys. Recalculating these added amounts isn’t fun.
What credit card companies don’t want you to know
On your credit card statement, you’ll see how paying just the minimum payment on the card’s due date slowly decreases your payback period. But what credit card issuers don’t want you to know is that by paying a second payment timed to decrease the principal, you’ll pay your cards off much faster, decreasing your repayment period by 50% or more.
Your window of opportunity
Each credit card has a 28-31 day billing cycle. Your payment due date is at the end of the first part of the cycle. This date becomes the target date for your repayment strategy. Add 10-14 days to this date to identify your window which is the second part of your card’s billing cycle. Payments made during this second billing cycle, will rapidly decrease your balance, because they are directly applied to principal alone, side-stepping any interest charges.
Cash strapped? Start with small payments you can afford, and increase these second payments as you can. The best results come about when you make the second payment equal to or greater than your required minimum. But things heat up when you start rolling over multiple minimum amounts as your second payment.
Accurately identifying this second payment window is important because if you make the second payments outside of the window, all you’ll be doing is making your next scheduled payment in advance, and you lose the benefits.
Watch the magic happen
As those second payment increases, the debt free magic will cause dramatic changes in your principal. I’ve been working this payment plan for years and really enjoy watching my card balances dwindle. I’ve paid off several major credit cards, and I can tell you it’s a blast to see “Paid in full” appear on my statement and in my credit reports.
You’ll also get the last laugh when those letters from former credit card issuers arrive, begging you to come back as a “preferred customer” and reactivate dead accounts by charging anew with “guaranteed” lower interest rates. Don’t fall for this krap else you’ll end up back where you started from. Let the borrower beware.