I'm all for taking credit where credit is due, but when it comes to credit cards, way too many of you are overdoing it. For Americans who don't pay their entire credit card bill each month, the average balance is close to $4,000. And when we zoom in on higher-income folks-- those with annual incomes between $75,000 and $100,000 -- the average balance clocks in at nearly $8,000. If you're paying, say, 18 percent interest on an $8,000 balance, and you make only the 2 percent minimum payment due each month, you are going to end up paying more than $22,000 in interest over the course of the 54 years it will take to get the balance down to zero.
That's absolute insanity.
And absolutely unnecessary.
If you have the desire to take control of your credit card mess, you can. It's just a matter of choice. I am not saying it will be easy, but there are plenty of strategies that can put you on a path out of credit card hell. And as I explain in the accompanying sidebar, even those of you who can't seem to turn the corner and become credit responsible on your own, can get plenty of help from qualified credit counseling services.
How to Be a Credit Card Shark
If you overspend just because you like to buy buy buy on credit, then you are what I call Broke by Choice. You are willfully making your own mess. I am not going to lecture you about how damaging this is; I'm hoping the fact that you're reading this article means you are ready to make a change.
But I also realize that some of you are Broke by Circumstance. I actually tell young adults in the dues-paying stage of their careers to lean on their credit cards if they don't yet make enough to always keep up with their bills. But the key is that if you rely on your credit cards to make ends meet, you must limit the plastic spending to true necessities, not indulgences. Buying groceries is a necessity. Buying dinner for you and your pals at a swank restaurant is an indulgence you can't afford if it will become part of your unpaid credit card balance.
But whether you are broke by choice or by circumstance, the strategy for getting out of credit card debt is the same: to outmaneuver the card companies with a strategy that assures you pay the lowest possible interest rate, for the shortest possible time, while avoiding all of the many snares and traps the card companies lay out for you.
Here's how to be a Credit Card Shark.
Take an Interest in your Rate
The average interest rate charged on credit cards is 15 percent, with plenty of folks paying 18 percent, 20 percent, or even more. If you carry a balance on any credit cards, your primary focus should be to get that rate down as low as possible.
Now then. If you have a FICO score of at least 720, and you make at least the minimum payment due each month, on time, you should be able to negotiate with your current credit card issuer to lower your rate. Call 'em up and let them know you plan to transfer your entire balance to another card with a lower rate -- more on this in a sec -- if they don't get your rate down.
If your card issuer doesn't step up to the plate and give you a better deal, then do indeed start shopping around for a new card with a sweet intro offer. For those of you with strong FICO scores, a zero-rate deal ought to be possible. You can search for top card deals at the Yahoo! Finance Credit Card Center.
Don't forget, though, that the key with balance transfer offers is to find out what your rate will be when the intro period expires in six months to a year. If your zero rate will skyrocket to 20 percent, that's a crappy deal, unless you are absolutely 100 percent sure you will get the balance paid off before the rate changes. (And if you got yourself into card hell in the first place, I wouldn't be betting on you having the ability to wipe out your problem in just six months...)
Once you are approved for the new low- or zero-rate card, move as much of your high-rate balances onto this new card. But don't -- I repeat, do NOT -- use the new card for new purchases. Hidden in the fine print on these deals are provisions stating, first, that any new purchases you make on the card will come with a high interest rate, and second, that you'll be paying that high interest on the entirety of your new purchase charges until you pay off every last cent of the balance transfer amount. This, to put it mildly, could really screw up your zero-rate deal. So please, use the new card only to park your old high-rate debt, and not to shop with.
Another careless mistake you can make is to cancel your old cards. Don't do that either. Those cards hold some valuable "history" that's used to compute your FICO credit score. If you cancel the cards, you cancel your history, and your FICO score can take a hit. If you are worried about the temptation of using the cards, just get out your scissors and give them a good trim. That way you can't use 'em, but your history stays on your record.
Coddle Your New Card
When you do a balance transfer, you need to protect your low rate as if it were an endangered species -- because if the credit card issuer has anything to say about it, it will be. Look, you don't really think the card company is excited about charging you no interest, do you? How the heck do they make money off of that? They only offer up the great deal to lure you over to their card. Then they start working overtime trying to get you to screw up so they have an excuse to change your zero interest rate, often to as much as 20 percent or more.
And the big screw-up they are hoping you don't know about is buried down in the fine print of your card agreement: make one late payment and you can kiss your zero deal good-bye. Even worse is that card companies are now scouring all your credit cards -- remember, they can check your credit reports -- to see if you have been late on any card, not just their card. So even if you always pay the zero-rate card on time, if you are late on any other card, your zero deal can be in jeopardy.
That's why I want you to make to make sure every credit card bill is paid ahead of schedule. Don't mail it in on the day it is due; that's late. Mail it in at least five days early. Better yet, convert your card to online bill pay so you can zap your payments over in time every month. And remember, it's only the minimum monthly payment that needs to be paid. That's not asking a lot.
When You Can't Zero-in on a Better Deal
If your FICO score is a good bit below 720, you're not going to get a zero-rate deal. At least not right now. But you can definitely change your credit profile and qualify down the road if you make the moves that will boost your score.
The first and most fundamental thing is to make your minimum monthly payment on time every month. That is the single biggest way to impress the credit score folks. After awhile, your record of paying on time is going to begin raising your FICO score.
Of course, it will also help to start paying down your balances, so your overall debt-to-available-credit ratio declines. This is another big factor in figuring your FICO score: the higher your ratio, the lower your score. For example, let's say you have a combined $5,000 in balances on three cards. And those three cards have a combined credit limit of $15,000. That means your debt-to-credit limit is 33 percent. If you can get your balance down to $4,000, your ratio falls to 26.7 percent. Keep getting the ratio lower and your FICO score will begin to move higher. (By the way, another tactic is to call up your credit card issuer and ask for your credit limit to be boosted. If your balances stay the same but your total credit limit rises, your ratio is going to fall. However, I am not suggesting that anyone with a spending problem take this route! The only time you should try this gambit is if you are convinced you will not run up more charges once your credit limit is raised.)
Dealing with High-Rate Debt
Okay, I realize not everyone is going to qualify for these low-rate balance transfer deals, so let's run through how to take control of your cards if you are stuck with higher rates.
I want you to line up all your cards in descending order of their interest rates. Notice I said the card with the highest interest rate comes first. Not the one with the biggest balance.
Your strategy is to make the minimum monthly payment on every card, on time, every month. But your card with the highest interest rate gets some special treatment. I want you to pay more than the minimum amount due on this card. The more you can pay, the better; but everyone should put in, at the minimum, an extra $20 each month. Push yourself hard to make that extra payment as large as possible. It can save you thousands of dollars in interest charges over time.
Keep this up every month until your card with the highest rate is paid off. Then turn your attention to the card with the next highest rate. In addition to the usual monthly minimum payment due on that second card, I want you to add in the entire amount you were previously paying on the first card (the one that's now paid off). So let's say you were paying a total of $200 a month on your original highest-rate card, and making a $75 monthly minimum on the second card. Well, now you are going to fork over $275 a month to the second card. And, of course, you'll continue to make the minimum monthly payment due on any other cards. Once your second card is paid off, move on to the third. If your monthly payment on that second card was $275, then that's what you should add to the minimum payment due on your third card. Get the idea? Rinse and repeat as often as needed, until you have all your debt paid off. For some of you this may take a year, for others it may take many years. That's okay. Just get yourself moving in the right direction and you'll be amazed how gratifying it is to find yourself taking control of your money rather than letting it control you.
And be sure to keep an eye on your FICO credit score. As you pay down your card balances -- and build a record of paying on time -- your score is indeed going to rise. Eventually your score may be high enough to finally qualify for a low-rate balance transfer offer.
The Two Dumbest Ways to Pay Down Your Credit Card Debt
Now that I've shown you what to do, I want to make sure you avoid two bonehead moves. Whatever you do, don't you ever use a Home Equity Line of Credit (HELOC) or a loan from your 401(k) to pay off your credit card debt!
The HELOC move may be popular, but popular doesn't equal smart. Your credit card debt is what is known as "unsecured." What that means is that if you default on paying this debt, the credit card issuer can't take possession of any asset of yours as a way of getting their money. A HELOC, on the other hand, is what is known as a secured loan; there is collateral on the loan so if you default, the lender can indeed grab that collateral as a way to get paid. And guess what? The collateral on a HELOC is your home. If you get behind on that loan -- say you lose your job, or become too ill to work -- and miss too many payments, the lender has every right to force you to sell the home to pay off the debt. So if you use a HELOC to pay off your credit card debt you are putting your home at risk. And remember that the interest rate on HELOCs are adjustable, not fixed. So if interest rates rise -- and we're in a rising-rate environment right now --- you will end up paying higher and higher rates on your HELOC. That's just another layer of risk you don't want. So, please, never ever use your home to solve your credit card problems.
Same goes with 401(k) loans. When you contribute to a 401(k) you use money that has not yet been taxed. But if you borrow against your 401(k), you will repay it with after-tax money. Then that money you have used to "repay" your 401(k) loan will be taxed again when you eventually make a withdrawal in retirement. I think being taxed once is plenty.
Besides, 401(k) loans are actually incredibly dangerous. You typically have just five years to repay the loan, but if you decide to leave for a new job -- or are fired -- you will need to repay the entire loan amount within a few months, or else the unpaid loan balance will be treated as a formal withdrawal from your account and you'll be hit with income tax on the amount of the withdrawal. Plus, if you are younger than 59 1/2 you are also going to get stuck with a 10 percent penalty.
Is Credit Counseling Right for You?
There is plenty of help available if you can't seem to get a solid grip on dealing with your credit card debt. But not all the help is good. Given that so many Americans are drowning in card debt, it's really no surprise that some enterprising -- and underhanded -- folks have figured out a way to make money off of this epidemic by charging high fees for counseling and advice.
So you need to make sure you choose an honest and fair credit counseling service. Start by getting references from the National Foundation for Credit Counseling.
Next, make an appointment to talk with a counselor face-to-face. A good counselor will question you thoroughly and in detail about your financial situation before proposing anything. . If you are simply told right off the bat that you need a Debt Management Plan (see below), you should run out the door PDQ. That firm is not interested in truly helping you. They just want to hit you up with a bunch of fees.
A good counselor is also going to require that you attend education classes. This is not punishment! On the contrary, it's the best help you can get. Quite often, you can make the changes necessary to take control of your credit card spending just by learning a few good habits.
Now, if you are in so deep you have stopped making payments, you may want to consider a Debt Management Plan (DMP). Your credit counselor will negotiate with your card issuers to set up an agreed-upon payment schedule. You will make one payment to your credit counseling agency, which will handle all the payments to your card issuers. Not everyone is eligible for a DMP; if your counselor doesn't think the plan will result in you having your debts paid off in a few years, you won't be allowed to sign on. >For those of you who qualify for a DMP, be extra careful that you know upfront every fee you will be charged. This is where some of those unsavory firms do their damage. You should pay a minimal start-up fee of just $25 or so, and your ongoing monthly service fee (which will be in addition to your monthly payment) should be lower than $20 a month. The average monthly fee charged by NFCC members is $14. Please don't fall for a credit counseling service that charges you hundreds in an initial fee and/or steep monthly fees. And make sure you pay just one monthly fee; some of the worst agencies charge a fee for each of your credit card companies that they deal with. Obviously, get all the fees explained to you in writing before you sign anything. Taking control of your credit starts with understanding your repayment terms.