How To Manage Credit Card Debt
An Overview of the Problem
Ah! The good 'ole days! Remember when interest charged on credit card debt was deductible from your income taxes? Really, it was! Well, most readers probably won't remember, but it was a terrific way of rationalizing the use of credit cards. Most of you have probably heard that the average American family has more than $8,000. in credit card debt. If this is true, it's a large amount of debt; and if each family has to stop spending so much in order to pay it, the economy will slow down. The interesting thing about this "fact" is that it is very misleading!
Most families have no credit card debt at all (23.8%), pay off credit card debt in full each month (31.2%), or have balances of less than $2,000. Only about 6% of families owe more than $8,000. on credit cards. These facts can be found in the Federal Reserve's 2001 Survey of Consumer Finances, which is updated every three years. The $8,000. figure came from CardWeb.com, which averaged credit card debt across the nation. But, consider this. If there are five people in a room and two of them are millionaires (10 million each) and the other three are worth about $500,000. each, the average worth will be $4,300,000. This doesn't accurately reflect the worth of the three poorer people in the room, and in the same way, the average credit card debt figure doesn't represent the debt of most American families. The families that carry large credit card debt skew the average to make it look as though all families are seriously in debt, but they're not.
Does this mean that we shouldn't worry about credit card debt? Well no. Thirty-six percent of families who owe more than $10,000. on credit cards have incomes under $50,000. Thirteen percent of that group have incomes under $30,000. Bankruptcies set a record in 2003, with over 1.5 million filed, according to the American Bankruptcy Institute. So, while the average American family is doing pretty well at staying out of debt, there are a large number of families who are seriously in debt.
How Credit Card Debt Affects the Economy
Here are some facts about credit card debt and how it affects the economy of the United States.
Over-spending income, failure to pay off credit cards and loans, and wildly increasing consumer debt can only affect the economy adversely when the spending becomes unmanageable. Then inflation increases and the economy slows down even more, leading to job losses, higher interest rates, and a recession.
How Credit Card Debt Affects an Individual's Long-term Financial Stability
Each $1,000 in credit card debt takes over nine years to pay off if only minimum payments are made! This might not be important except for the fact that family members continue charging on credit cards regularly, while trying to pay off past debts. Some families never get out of debt, continue to increase debts, and become so bogged down, they can't continue meeting the minimum payments required.
Families who have large amounts of credit card debt cannot afford a down payment on a house or the large monthly payments needed to buy a house. They have no way to save for retirement or for college educations for the children. Their savings accounts don't grow, as funds must be continually drawn out for credit card, house, and emergency payments. Retirement becomes less possible. Any unusual need for funds can lead to bankruptcy and loss of the ability to get credit. The long-term financial stability of the family is ruined.
If a divorce occurs, the family is left without resources to draw on and if they have a house, it often must be sold, as neither partner can afford to keep it or buy another one!
Ways to Reduce Credit Card Debt
What are the best ways for reducing credit card debt? There are many programs and services which will help families and individuals pay off credit cards, but the best thing to do first is to go to a counseling service. The counseling service (which should be free or low cost) will give assistance in how best to address financial problems. It will also make referrals to planners who can help, but who will not create more debt or ruin the individual's credit. A counseling service can also recommend programs, services, and tools to use in debt reduction.
The reduction of credit card debt can take place by DOLP (dead on last payment) or by paying off the cards with the highest interest rates first. Which is best? Most of the debt calculators on the Internet are programmed to pay off the highest interest rate debts first. This is because an interest rate of 25% on $1,000 costs 10% more per year than an interest rate of 15%. The sooner you get rid of the higher rate debts, the more money you save and the faster you can pay off the rest of the debts.
If you use DOLP, you will be advised to pay off the smallest debts first so that you will see an immediate reduction in debt, giving you a positive psychological result. This will motivate you to pay off more as quickly as possible. DOLP also keeps late payment fees on multiple credit cards from adding up, by reducing the number of cards you are paying on as quickly as possible.
Which one is best? If you are motivated and make payments on time, the highest interest rate method is best. If you are discouraged and often miss payments, DOLP is best.
It's a good idea to have an emergency fund set aside in case you can't work for a few weeks, have to pay a large car repair bill, or face missing a credit card payment. Late credit card payments result in penalty fees and increased interest rates, so an emergency fund can help you avoid those charges. Set up a chart of all payments, when they are due, and check them off as soon as you make them. Make the payments as soon as you get the bills in the mail to avoid late fees. Online banking makes paying easy and fast.
One suggestion to reduce debt is to move credit card debts to cards with the lowest interest rates (i.e.; 10% or less; ideally 6 or 7%) or move some debt to cards that offer no interest for a period of time. However, be sure you can completely pay off the amount moved by the time interest resumes. Also, transferred debts will be paid last by the credit card company; they will use your money to pay off bills you charge, first. The longer they wait to pay your transferred debts, the more likely that they will still be on the card when interest resumes on them. Also, be sure there are no fees or only small fees added for transferring balances from one card to another. If you can't get a low interest credit card, pay your payments religiously for six months and then request a reduction in the interest rate. In the future, get only cards with low rates and those that must be paid off at the end of each month.
Another way to reduce credit card debt is to contact each card company and speak to someone about reducing the amount you owe. Often, companies would rather take partial payment than get nothing if you go bankrupt. Explain your extenuating circumstances (loss of job, your illness or accident or a family member's that created large medical bills, disaster situations, deaths in the family, a change in jobs that reduced your salary, a new baby, inability to work to due illness or accident, a divorce, a depression, a forced move or sale of home, etc.) and mention the possibility of bankruptcy. Ask for: a reduction of the total amount of debt, a reduction in interest rates, and/or a delay or extension of time in which to pay off the debt. It can't hurt to ask! Any amount that is "forgiven" by a company is considered income and you will have to pay taxes on it.
Consolidating Credit Card Debt
Many people decide to use credit card consolidation as a way to pay off their debts. This can work well, as long as you don't continue charging while you pay off the large, consolidated debt! It is best to consolidate your debts yourself. If you use a debt consolidation company, you must be very careful about the one you choose to consolidate your debt and pay it off for you, allowing you to make payments over time. Some bad companies will wait until the very last day to pay off your debts, before they are turned over to a collection agency, in order to use your money as long as possible. This can ruin your credit rating. (See below.) If you do consolidate, cut up or cancel all but one or two credit cards so you won't be tempted to keep charging.
Consolidating onto Credit Cards
Should you consolidate your credit card bills? If your credit cards all have nearly the same interest rates, there's little point to consolidating them on one card. Do not use cash advances to pay off credit card bills, as these have very high interest rates and transaction fees. Consolidate your debts onto one or two credit cards that have the lowest interest rates you can get (as far under 10% as possible). Bargain for those rates! Make sure you won't have to pay high fees for moving balances. Make sure the interest rates are permanent, not just temporary for six months or a year.
Debt Consolidation Mortgages
Consider a debt consolidation mortgage or mortgage line of credit. This is a loan from a bank or loan company that uses your house as collateral. It will combine all your debts into one, including car loans, credit card debts, and your mortgage. If you have equity in your home, you can refinance it and get a new mortgage or take out a line of credit. A line of credit does not refinance the house, but adds to the amount owned on it. The money is put into a bank account and you use it as needed. Even with bad credit, you can usually do this, if your home has significant equity. Beware! If you fail to pay the loan, the bank can take your house! The better the interest rate you can get, the lower your monthly payment will be. Usually these loans can be made for 15, 20, 25, or 30 years. Also, the interest you pay will be tax deductible. Research carefully to find a loan with the lowest fees. Remember! You will pay more in the long run in interest on your debts with these loans, due to the longer payment period.
If you don't want to refinance your home, consider taking a second mortgage on it.
Secured Debt Consolidation Loans
Even if you don't own a home to use for collateral, you may still be able to qualify for a secured debt consolidation loan. Many banks will approve autos, boats, property, or jewelry as collateral. Some even accept stocks, bonds, and mutual funds as collateral.
Unsecured Debt Consolidation Loans
If you have nothing to use as collateral, you can still get a debt consolidation loan. You need to find a bank that is willing to accept your verbal and written promise to repay the money. To improve your chances of getting an unsecured loan, get your credit reports and do your best to improve your credit rating before applying for a loan.
Debt Consolidation Settlement Companies
Debt consolidation settlement companies charge hundreds of dollars to create an account for you, plus a monthly service fee. The fees vary, based on the company and the amount of debt. Debt settlement companies collect a payment every month, but don't make monthly payments to your creditors. Instead, they put your money in a trust account and earn interest on it for themselves for as long as possible, while negotiating your debts with your creditors. Finally, they make a payment when there's enough in your account to pay in full. This can take years. Meanwhile, you can be sued by your creditors and your wages garnished! Also, settlement companies don't get the interest and late fees on your debts stopped; those continue to pile up, along with their monthly service fees. The bad settlement companies do not tell you these facts; in fact, some claim to be non-profit! Usually, you find out the truth only when you are sued or your credit is ruined. You can negotiate with creditors yourself. It's better to do that and use the money you would have given to a settlement company to pay off your debts as soon as possible and save your credit rating.
Monitoring Your Credit Cards
It's important to keep tabs on your credit card bill and compare credit terms and conditions before accepting a card. Always shop around for cards with low interest rates and consider accepting those that you pay off at the end of each month. Take advantage of no interest time periods only if you can pay off the charges before the interest resumes. Never accept a card that involves a yearly fee!
A credit card represents a type of loan and issuers must inform you of the APR (annual percentage rate), the cost of credit per year, and the periodic rate, the rate applied to the balance in order to figure finance charges for each billing period. These facts must be revealed when you apply for a card and on the card statements. Some cards have variable rates, i.e.; interest rates that change as the economy changes. The credit card company must tell you if you are accepting a variable rate card, how the rate will be determined, and how much and how often the rate may change. If there is a "grace period" you must be told. A grace period allows you to avoid finance charges by paying in full before the due date. If there is a grace period, your bill must be mailed to you at least two weeks before the due date. Always look for a grace period because it reduces the interest on your balance! If annual card fees are required, you must be told. Avoid them! You can find plenty of good cards that don't have them. You must also be told if your card charges fees for cash advances, late payments, or exceeding your credit limit. Some charge monthly fees, even if you don't use the card! Avoid those, too. If you get charged an occasional late payment fee, call and ask to have it removed. Usually, card issuers will remove them.
It's important to know the method each card uses to calculate finance charges. Some use an Average Daily Balance (your total balance for each day of a month is added up and divided by the number of days in the billing period). Some use an Adjusted Balance (payments received during the billing period are subtracted from the balance at the end of the previous billing period and purchases made during the billing period are not averaged in). Others use a Previous Balance (the amount owed at the end of the previous billing period, not including payments and new purchases made during the current billing period). Another method is the Two-Cycle Balance (these vary, but issuers use the prior two month's account balances).
The Adjusted Balance is the most advantageous method. If you pay off your charges made during a billing period by the end of it, you don't pay interest on them.
In choosing a credit card, it's important to consider how you will use it, the annual fee and other charges, the periodic rate and APR, the grace period, the cash advance features, and the method used to calculate your balance. Also, think about the credit limit, where the card is accepted, and other services and features, such as bonus points or donations made by the company to charities.
Your Rights Based On Federal Law
You have rights with regard to credit cards. No one can send you a card you didn't request. Issuers can, however, send you a renewal card or an application for a card. An issuer must credit a payment to your account the day it arrives. When you return something or overpay, you may keep the credit on the account or write for a refund. A refund must be issued in seven days, after receipt of the request. If the credit remains for six months, the issuer must send you a refund. Issuers must correct billing errors immediately. If there's a mistake on a credit card bill, you can withhold payment of that charge until the claim is investigated. If your card is used without permission, you are responsible for up to $50. per card. If you report a lost card prior to its use, you are not responsible for any charges at all.
To dispute a charge, write to the creditor at "Billing Inquiries" including your name, address, account number, the date, and description of the mistake. It must be sent within sixty days after the first mistaken bill was mailed. Within thirty days, you must receive a reply. The error must be resolved within two billing cycles of not more than ninety days.
Alternatives to Debt Consolidation, DOLP, Paying off Highest Interest Rate Cards First, Loans, and Mortgages
Before considering debt consolidation, DOLP, paying off the highest interest rate cards first, and getting a loan or refinancing your home, you may want to follow some of these suggestions for credit card help.