Most people owe money these days, and the average debt burden is about $50,000. And while banks can borrow from the government for next to nothing, you still have to pay 17% interest on your credit cards. It’s no wonder you’re feeling overwhelmed.
So you owe money. Okay, it’s a lot of money.
The insidious thing about credit cards is that you keep paying and paying, but your balance never seems to get much smaller. Problem is, making the minimum payments your bank wants won’t make your debt disappear. One day you will wake up and you’ll be 73 years old and you’ll wonder what you bought in the first place.
There has to be a better way, and there IS a better way.
Never miss a payment.
Pay your bill the day you get it. Many card companies will let you pick the date your payment is due, so if you know that a particular time of the month is bad for your cash flow, change the schedule to something that works better. While you’re at it, sign up for online billing and payment if you haven’t already; this will save time and protect you from having to scramble if your bill gets delayed or lost in the mail. (You can even sign up to have your card company send payment reminders to your email or your cell phone in case you forget.)
Simply paying on time will help you avoid late fees (which can reach $25 for a single overdue payment) and rob banks of an excuse to jack up the interest rate on your existing balance—these penalty rate hikes typically double or even triple the interest you pay.
And don’t forget: Late payments go on your credit report and, if you miss a payment entirely, they have a big impact on your credit score, making it harder for you to get loans and low rates in the future.
Pay off higher rates before low ones.
Ideally, you should pay off all your cards every month. If you can’t, your best plan is to attack your balances from highest interest rate to lowest. (Check your card agreements or ask your bank if you don’t know what your current rates are.) That’s because you may owe a lot of money on a card that’s actually charging a fairly low interest rate, but if you’re also carrying a smaller balance on a high-rate card, the smaller balance is actually costing you more money per dollar of debt.
Want evidence? Let’s say you owe $3,000 on a balance transfer card charging 7% and $850 on a department store card charging 25%. If you just make the minimum payments on both cards, you’ll pay $198.88 in interest on the big balance over the next year—but you’ll pay $201.41 on the small balance. It’s a slightly extreme example, but you get the idea. (Naturally, if the big balance is also the high-rate balance, it’s going to be even more expensive, so do everything possible to pay it off as fast as you can.)
Once you pay off a card, think twice before canceling it. If you owe money on other credit cards, closing an account will make those balances look bigger compared to your remaining credit limit, and that will probably hurt your credit score.
One tip: Use any savings you have to pay off high-rate credit card debt. This may feel like a “waste” of your savings. It’s not. Paying off debt that charges you a rate of 17%—the national average charged by credit card companies—is the equivalent of earning a guaranteed, tax-free rate of 17% on your money. (No other investment out there can guarantee that kind of return.) Apply your savings to your highest-rate debt; if you have any money left, move on to the next-highest-rate account.
Another tip: Look into transferring your high-rate balance to a lower-rate card. The card you transfer the debt onto can be either one you already have or a new card you apply for separately. Add up the transfer fees before you do this to make sure you’re actually saving money. (Many credit cards will charge you up to 3% of the balance you transfer onto them.)
Pay more than the minimum (and get a lower rate).
If you can’t pay off your accounts in full and you’ve already spent your savings, you can at least pay more than the minimum your credit card company requires you to send in every month. Paying just a few dollars extra every month can make a huge difference. Let’s say you’ve got $3,000 sitting on a credit card that charges you 17%. If you pay just the minimum every month, it will take you 23 years and over $5,600 in interest to pay off your debt. But if you sent in just $10 a month more than the minimum, you’d shave 17 years off your payment schedule and save $4,000 in interest.
Meanwhile, try to get a lower rate on your credit cards-or get a lower-rate card. Call your card company and ask for the retention office. Explain your situation and see if the company will lower your interest rate. If not, look around the Internet for a company that will give you a better deal.
If you have a lousy credit rating, you may not be able to get a rate below 10%. But if you’re like most people, you can probably consolidate your debt and get at least a slightly better deal than the one you currently have.
Pay off your credit cards before your student loans.
If you have student loans and credit card debt, you may want to pay off your student loans more slowly—say, over 20 years instead of 10. That will reduce your monthly student loan payments. Then you can take the cash you save each month (yes, all of it) and use it to pay off those higher-rate credit cards. My favorite sites for handling student loans: finaid.org; ed.gov/DirectLoan.
If you’re having real trouble making payments on your debts, you may need help. Here are a couple of options. Borrowing from friends and relatives. People who are close to you may be willing to lend you money to pay off your debts, but keep in mind that when you borrow from friends and family, you put your relationships on the line, not your credit rating. Offer to pay them back with interest, and, even if they refuse, be sure to establish a clear payment plan, preferably in writing. If you stick to it, it will work out well for everyone. (For more tips, see my blog on making friendly loans less awkward.)
Negotiating with your lenders. If you haven’t already, contact your lenders and explain your situation. They may be willing to arrange a payment plan to suit your needs. If this doesn’t work, a credit counseling service might be able to help you negotiate a better payment schedule or even reduce your interest rate. The National Foundation for Credit Counseling is a nonprofit organization that offers free budget advice and inexpensive debt management service and may be available even if you can’t pay at all.