More than one billion credit cards are in use in America today. Used wisely, they can be valuable tools for consumers, but their use represents a substantial portion of Americans' consumer debt problems. Taking control of one's debt with a systematic plan for debt reduction is the key to success.
Getting out of debt is an investment
Paying off the balance on a credit card is just about the best investment one can ever make. Not having to pay 18% or 22% interest on a credit card is just as good as earning 18% or 22%. Risk free. Tax free.
For someone who runs a balance on a card, life is 20% more expensive than it needs to be. If you charge $1,000 on your credit card and pay just the minimum monthly requirement, it could take more than 20 years to pay back that $1,000-- and you will have paid about $2,000 in interest along the way.
Problems of High Debt
- Cost -- Many consumers carry consumer debt of more than 20% of take-home pay. This is like working a five-day week and getting paid for four, because an entire day's pay is unavailable to use for current expenses.
- Long-term debt -- Paid at minimum payment levels, high-cost debt becomes long-term debt.
- Emotional distress -- Feelings of guilt and shame, quarrels and destructive behavior patterns often emerge when families become financially stressed.
- Life on “the edge” -- Families that live from paycheck to paycheck are at risk of financial disaster when an emergency or sudden loss of income occurs.
Select Appropriate Credit Card
Credit cards are one of the most expensive ways to borrow money; most consumer debt is money borrowed on plastic. Comparing credit card pricing structure (interest rate, grace period, fees) can save money. The key to selecting an appropriate card is for consumers to decide how they will repay their debts. If you:
Carry a balance most of the time? Look for a card with a low interest rate. The larger your balance, the more important a lower interest rate becomes. With a $10,000 balance, interest would cost $2,000 on a 20% card and $1,200 on a 12% card B an $800-a-year difference.
Pay your balance monthly? Choose a card with no or low annual fee and a grace period.
Charge frequently and avoid interest charges? Consider an enhancement card that offers rewards based on the dollar amount charged.
Charge frequently and pay balance monthly? Consider an enhancement card. These cards offer rewards based on the dollar amount charged. Typical rewards include cash, airline ticket or free gas. However, for cardholders who carry a balance, enhancement cards can be expensive.
To Reduce Credit Costs
Choose lower rate options. There is no reason to carry a high rate card when lower-rate options exist. One source of information about low-rate credit cards is www.cardweb.com
Shun retail accounts. Retailers charge some of the highest interest rates (18%-22%), yet they also accept bankcards. Consider closing store accounts.
Avoid high interest cash advances. Credit card cash advances charge interest rates up to 25% or 30%. Few issuers offer grace periods on cash advances. Interest charges begin to accrue immediately and continue until the bill is paid in full. Many credit cards charge a cash advance fee that is based on the amount of the advance.
Be cautious of transferring balances to cards with low interest teaser rates. These low interest rates are effective for a short period and then jump to much higher rates. Many consumers take advantage of this offer to transfer an existing balance (cash advance) to a lower rate card, but, if the balance is not paid off at the end of the teaser rate, the end result is a much higher cost.
Avoid nuisance fees. Costly credit card nuisance fees include over the limit charges, late fees, transaction fees and cash advance fees. These fees may cost as much as $25 - $49.
Pay bills promptly. Promptly paying credit card bills will reduce their average daily balance and lower interest fees.
Negotiate lower cost. In today's highly competitive market, many credit card issuers will reduce fees and interest rates, upon request, to attract or maintain the business of customers with good credit histories. Gather information, and think through the issues before contacting the lending agency. Calmly and rationally justify your request for a lower rate.
Repay high interest debt with low interest savings. Consumers with debt, but with more than adequate emergency savings or investments, are advised to rethink their situations. It is unwise to pay high interest on a credit-card balance while earning low rates in a savings account. Repaying a 15% debt is equivalent to earning 15% guaranteed and tax free.
Avoid minimum payments. By making minimum payments on an outstanding balance, you will pay more in interest charges. This is especially true if you continue to charge on the account. It would take 23 years and two months of 2% minimum payments to repay a $2,000 balance on an 18% credit card.
Shun skip-a-month payment. Usually offered shortly before or immediately after the holiday season, these offers give consumers an option to skip or defer payments for a period. Remember that interest charges still continue when payments are missed. Additional charges may also apply.
Consider Power Payments
Power payments can reduce debts significantly without changing the total amount being paid monthly to creditors. The first step is to repay one initial debt completely. Next, the money used to repay the initial debt is applied (folded down) to a second debt, in addition to the amount that had previously been paid. All other monthly payments remain the same, as does the total monthly dollar amount allocated to debt repayment. This process continues until all debts are paid.
The LSU Agricultural Center can provide debt repayment analysis calculated with the PowerPay8 computer program. This program:
- Computes and summarizes the reduction in pay-off time
- Calculates savings that can be achieved with a variety of payment schedules
- Provides a personalized monthly repayment schedule (calendar) for each debt
- Computes interest savings made possible with additional monthly payments or lump-sum payments.
Contact your local LSU AgCenter Extension office to schedule a free PowerPay© Debt Reduction analysis.
Professional Debt Counseling
Professional debt counseling services offer financial counseling to assist households who have or wish to avoid serious debt problems. There is generally no charge for counseling sessions. Consumers who enter a debt management program agree to commit a specific amount each pay period toward debt repayment. Program participants are required to surrender or destroy their credit cards and incur no further debt while participating in the program. A nominal fee may be required for administrative costs. Select a debt counseling service associated with the National Foundation for Consumer Credit.
References
Bowen, C.F. (1997). Ten Ways to Reduce Debt. Unpublished manuscript, The Pennsylvania State University, Department of Agricultural and Extension Education.
Consumer Credit Counseling Service. (1999). It's All About Money. Baton Rouge, La.
Consumer Federation of America. (1999). Debtors Exercise Restraint While Credit Card Issuers Expand Marketing, Lines of Credit and Profitability. Washington: D.C. Consumer Federation of America.
Dakake, B. (2002). Deflate Your Rate: How to Lower Your Credit Card APR. In The Truth About Credit [Online]. Available: http://www/truthaboutcredit.org.
Garman, E.T. & Forgue, R.E. (1997). Personal Finance. Boston: Houghton Mifflin.
O'Neill, B.M. (1995). Americans and Their Debt, Right-sizing for the 90's. Journal of Financial Planning. 8 (1). 20-28.
O'Neill, B.M. (1995). Dealing with Debt. Unpublished manuscript, Rutgers Cooperative Extension Service.
O'Neill, B.M. (1999). Investing on a Shoestring. Chicago: Dearborn Financial Publishing, Inc.
Tobias, A.(1998, November 1). Take Control of Your Credit Cards. Parade, (4-6).