Digging out of the credit card hole
(Article by Austin Pryor with Cindy Biller from Sound Mind Investing, 2003)
If you're carrying credit card debt from month to month and paying those nasty finance charges you're probably already looking for a way to dig out of the credit card hole. So, how do you do it?
- Assess your situation. It may be painful, but lay it all out on the table. Compile a list of all of your credit cards, debt amounts, interest rates, and monthly payments.
- Develop and implement a spending plan strategy. Sit down with your spouse and evaluate your budget. Decide where to "tighten your belt," and allocate as much as you can to paying off your credit card balances quickly. You may have to make some tough decisions, like whether or not you can afford your car, house, or life-style. Determine to stop using credit cards entirely until you're out of credit card debt.
- Find the lowest rate. If you're currently carrying a balance from month to month, you should focus on finding the lowest effective interest rate. Since you don't pay off the full balance each month, grace periods probably don't affect you, even if the card has one.
Be aware that not all interest rates are created equal! Because of differences in calculation methods, total finance charges may vary significantly between cards with identical APR's. So, in order to make an "apples-to-apples" comparison, it's important to understand how they're calculated.
Now you're ready to make some money-saving changes. First, call your existing credit card companies and negotiate for lower rates.
Marc Eisenson calls this "Dialing for Dollars." In his newsletter, The Pocket Change Investor, he writes:
"Each of your statements lists a customer service number. Call, and say the appropriate version of 'You're charging me a $20 annual fee, plus 19.8% interest. I'm seeing a lot of cards advertised with much lower rates and no annual fees. Will you waive my fee and lower my interest rate?' If you have at least a one-year history of timely payments (even of only the minimum required), the answer will probably be 'Yes.' You don't have anything to lose, and not asking is an automatic 'No!' Be tough, if necessary. Don't expect an immediate 'delighted to be of service.' You'll likely be put on hold while your record is reviewed. If the verdict isn't to your liking, ask if they would prefer that you trade in their card for a better deal from one of their 6,000 hungry competitors.
If that doesn't prove fruitful, then it's time to begin playing the "Transfer Game."
You've probably heard about this transferring an existing balance to a new card in order to get a low, introductory interest rate. Some people shuffle their balances from one card to another when the introductory period expires. By doing this, all of their payment goes toward reducing the debt's principal, rather than paying interest. Since this reduces their profitability, credit card companies are making the process more expensive. Many are now charging "transfer fees" or treating transfers like cash advances.
To find the best deals, gather all of those junk-mail credit card mailings. Line them up and look for the best offers. Read the small print and if anything is unclear, don't hesitate to call the issuer for the answers you need.
Some important questions to ask before transferring your balance include:
- Is there a balance transfer fee?
- How long does the introductory rate last?
- Does the introductory rate apply to both transferred balances and new purchases?
You're well on your way to escaping the credit card pit, but a few additional steps remain.
- Close old accounts. As you pay off and transfer balances, close unnecessary accounts immediately. Your total available credit line will be analyzed to determine your credit risk to a given credit card company (which in turn affects the interest rate they're willing to give you). There's a possible exception, however. If you've always been prompt in your payments and have a good standing with a credit card you've used for a long time, that can improve your credit score you may not wish to close such accounts.
- Pick a payment strategy. Most folks in debt make it a priority to pay off their highest rate cards first. I tend to favor paying off the lowest balance cards first.
Additionally, consider the following ideas:
- Make the most of your grace period. Some experts suggest having two credit cards on hand: (1) a low-interest card for carrying balances, and (2) a no-fee card with a 25-day grace period to use for charges you will pay off that month. This allows you to utilize the 25-day, interest-free grace period you would otherwise lose by carrying a balance.
- Make more frequent payments. Interest accumulates every single day you carry a balance. So, you can reduce the amount of interest you pay simply by sending in payments every two weeks instead of just once a month. Tell the company in advance that you will be sending biweekly payments, and ask them what you need to do to get them processed quickly.
- Beware cash advances. If at all possible, do not get cash advances on your credit card. Most cards charge a cash advance fee of 2%-4% of the advance amount. Upon taking the advance, interest begins to accrue immediately at a rate that is typically higher than your regular interest rate. Lastly, any payments you make will be applied to the lower interest balances first!
- Stay on top of things. Credit card companies can change their terms quarterly or by written notice, so pay attention to everything they send you. They may decide to increase your interest rate because they feel your risk has increased. Watch out increasing your credit limits or making late payments (to them or any other creditor) may qualify you for a rate hike! Make sure to check your credit report annually (see Don't Miss Taking Your Annual Credit Report Checkup).
- Celebrate as you go! You're following a long, hard road, so it's important to celebrate when you've reached certain milestones, like paying off an account or reaching the halfway point. Be creative get the family together for a bill burning or bake a cake!
Adapted from "Credit Cards: Are You Using Them or Are They Using You?," Chapter 3 of Sound Mind Investing, A Step by Step Guide to Financial Stability & Growth (3rd Edition) by Austin Pryor. Copyright © 2000. To order a copy of this book at a 35% discount, visit our bookstore.