Thursday, July 8, 2010

Managing Credit Card Debt

Many, if not most Americans get into trouble with Credit Card debt at some point in their lives. How do you dig your way out of this insidious mess?

Credit Card debt is a lot like being overweight, as I have written before. Both are a result of over-consumption, and both can sneak up on you over time. Before you know it, you are 100 pounds overweight and tens of thousands of dollars in debt.

Both are also similar in that major corporate interests want you to over-consume and count on your moral weaknesses to get you to indulge in over-consumption. Simply stated, they make money by catering to your psychological weaknesses - the human tendency to want more, to want it now, and to not think about later consequences.

And both are similar in that it is not easy to lose weight or to pay off credit card debt. It takes time to get rid of that gut and that credit card balance, and it is hard work that involves sacrifice, discipline, and moral fortitude.

And both are similar in that there are thousands of snake-oil salesmen out there promising that you can lose weight quickly or cut your credit card debt in half, with no effort on your part. And of course, both are utter and outright lies.

This latter phenomenon deserves special mention first. While listening to the radio the other day, I was chagrined to hear an ad for one of those credit card debt outfits. The promised to "cut your credit card balance in half" under a "new program" (which was obviously designed to make it sound like a government program). Sounds too good to be true, right?

And if it sounds too good to be true - well, it is. These fraudulent "debt counseling services" get you to pay them a fee up-front, often in the thousands of dollars. They then tell you to stop making payments on your debts, and "escrow" the payments to them. They then "negotiate" with the credit card companies to reduce your debt - threatening your personal bankruptcy as a leverage with the credit card companies as a stick to get the debt re-negotiated.

Unfortunately, all that usually ends up happening is that you DO end up in bankruptcy, and are a little poorer for having send these people your money. And under the new bankruptcy laws, you can't discharge the debt as easily as before.

If you really are so far into debt that you cannot pay off your debts, then talk to a legitimate bankruptcy attorney (preferably not one that advertises on a lamp post) and then talk to several more. Bankruptcy is a serious business these days and not something you want to enter into through the back door, by way of a "credit repair agency".

So if these come-ons on the radio and TeeVee don't work, how do you pay off credit card debt? Well, the same way you lose weight - a little at a time. The deal is, you have to manage your credit card debt and have a plan to pay it off. If you fail to do this, you can end up in a lot of trouble in a real hurry - with interest rates so high on your cards that you may never be able to realistically pay off the debt. Those smiling people at the credit card companies are little more than the cousins of Louie "kneecap" Jones, the local loan-shark.

The first step to managing credit card debt is to not take it on in the first place. This means shredding those enticing offers that come in the mail and not using your cards. Of course, this is hard to do, as you are bombarded with offers, if you have a pulse and an address (pulse is optional, dead people get credit card offers all the time). If you get a truly low-interest offer in the mail, you might want to consider it, but we'll discus more of that later.

Most people who get deep into credit card debt don't do so over big-ticket items like flat-screen TV's or cars. Rather they nickel-and-dime themselves to death by "shopping" at stores for clothing, or eating out at restaurants. $50 here, $100 there, and pretty soon they are into debt up to their eyeballs, paying 2-3 times in interest over the original purchase. That $12 hamburger becomes a $25 one, when you put it on a credit card and pay it off over time.

Thus, not using the card is the other half of not taking on debt. Again, this can be hard to so, as our whole society is set up for the credit card swipe. Using a debit card is one alternative, and one that is more attractive as of late. Under the new banking laws, banks cannot charge you overdraft fees if your debit card is declined (no available balance). So you can use your debit card, and if you go "over your limit" not worry about bounce fees.

Of course, this is a bad way to balance your checkbook, and you should carefully monitor any bank account balance and keep track of all spending. The credit or debit card is evil in that it disassociates the spending of money from the brain. When you hand over cash, it is a transaction that you cognitively register in your brain, whereas the "swipe" of the credit card often doesn't register as spending for most people. Knowing your bank balance at all time (check this daily!) and how much you can spend are vitally important. If you can't keep up with this sort of thing, then consider going to an all-cash lifestyle.

Speaking of overdraft fees, the new banking laws make it illegal to charge over-limit fees on credit cards. If you go over your limit, the charges should be declined. Wily credit card companies have taken to calling customers and asking if they would like the "convenience" of being allowed to charge over their limit. What this means is, you go over your limit, they accept the charge, but sock you with a $25 fee. Just say "no" to such "friendly offers".

The second step to managing Credit Card debt is to track it. This means checking your balance on a weekly or even daily basis. You should know your statement date, payment due date, and interest rate on your card(s). You'd be surprised how many people have only a vague idea of these things, and then just shrug their shoulders when they get a letter from the credit card company telling them their interest rate has been jacked to 25%. In order to get out of Credit Card debt, you need to keep track of it, and chart it over time. I use a simple chart in Microsoft WORD, but you could use a piece of paper for this purpose. Each month, keep track of your Credit Card balances and overall debt and then plot it as a graph. It should be trending downward. If not, you need to take action. Put the chart in a prominent place in your home office so you see it every day. Awareness is the key to both weight loss and debt reduction.

Setup AutoPay to avoid rate jacking: A lot of the worst practices of rate jacking are a thing of the past now. But missing a payment can trigger a rate increase. So setup autopay to pay the minimum on your card every month, so they can't argue you are "late" on your payment. If you are one of those people who likes to say "I don't trust those newfangled computers or paying online!" just grow up, OK? The time for that sort of "dagnabbit"-ism has long since past. Relying on the US Mail to get your check there on time is far more dangerous than using the Internet to automatically debit your account.

And if you are not comfortable with using auto-pay because you are afraid of overdrawing your account, then you need to start working on your banking skills. Again, you should be checking your bank balance nearly every day (I do, you can too. The Internet makes this easy). The auto-pay amount will appear on your online credit card statement (which you check the day it is posted, again on the Internet) and you can enter the amount in your accounting software.

Now note that I am NOT SAYING to ONLY pay the minimum amount every month! Only that your auto-pay should at LEAST pay this amount to prevent a "late payment" scenario from occurring. You can and SHOULD pay an additional amount every month, if you want to attack the balance. And yes, if you go online to your Credit Card website, you can make payments, any time of day or night, any time of the month, electronically. It is not rocket science.

Payoff higher interest rate Cards first - get lower rates: Interest rates on credit cards these days can be as low as 5-6%, or about the rate of a mortgage. They can also be as high as 30%, or the rate a loan shark gives. These higher rates are so high that you realistically will never pay off the debt - at least not for a decade or more. Getting lower rates, and keeping them, is essential.

In this regard, sometimes - sometimes - you may get an offer in the mail which is worth considering. If you have bad credit, you will not get such offers, of course. And you can call credit card companies directly and ask them for cards, rather than waiting for offers in the mail.

I was able to obtain a card from Citibank at an attractive rate (5.99%). Capitol One also offered attractive rates (7.15%) as well. Other cards, such as Discover, are in the double-digits, and many of the "come on" offers, as well as airline miles cards, have rates over 20-25%. Just avoid these high-interest rate cards entirely. As I have noted before, the concept of "paying off the balance every month" is a high-wire act that can go horribly wrong the first month you can't pay off the balance (when you need that emergency plumbing repair, for example). And it is a high-wire act with no safety net. Free round-trip tickets to Duluth are not worth 5 years of high-interest debt.

Balance transfers can be used - in some cases - to get out from under high interest-rate debt. But these have to be used carefully. In many cases, they charge a 3% transfer fee, which adds on to the total debt. And make sure the "teaser" introductory rate doesn't morph into a staggering rate later on, or you'll end up poorer than you were before.

Home Equity Loans and Refinancing are tricky: One reason many people are in trouble today is that they paid off staggering credit card debts using home equity loans or by refinancing their homes. Many of the "come on" ads on the TeeVee and Radio are just pitches for home equity loans. While such a scheme can provide some relief for the borrower, bear in mind that you are refinancing your debt on 30-year terms now, and the overall interest paid will be higher.

Worse yet, most consumers, relieved of high monthly debt payments (now lower monthly debt payments due to longer amortization) will simply go out and rack up a new set of credit card debts.

In addition, home equity loans and refinancing offers often add thousands of dollars in fees and closing costs to your debt load. So while you may get temporary relief from monthly payments, you are literally mortgaging your future. The day of reckoning will still come - you've just put it off for a few years.

So how can you pay off this debt? Well, presuming you have a reasonable interest rate (less than 10%), it makes more sense to attack the debt head-on than to try to refinance it through a home equity loan or other dodge. If, like most Americans, you have multiple cards, figure out which have the highest interest rates and pay those down first.

Interest can make a big difference in how fast you can pay off debt, and paying off higher interest rate cards first is important. $10,000 in credit card debt on a 7% interest card may accumulate about $50 a month in interest. But at 15%, this rises to over $100. And at 25% to $250 or more. If you are paying $250 a month toward the debt, you will make progress at 7%, but will actually fall behind at 25%.

Some financial gurus preach paying off the lowest balance debts first, so you will see "progress" by clearing out a debt. But while this may provide psychological satisfaction, it really delays the ultimate payoff of your debt.

Not using the cards - ever, every, is the second key. This can be hard in our credit-card based society. For me, as a self-employed person, credit cards can be a convenient way of tiding yourself over until a slow-paying client pays me or if I need to pay a government fee on their behalf. But such a technique can be dangerous, as with the interest charges, you end up falling further and further behind.

Cutting spending is the key - and I have gone into detail in this blog of all the creative ways you can cut spending in your life and live just as well, if not in fact better. Paying $100 a month for Cable TeeVee while at the same time having a staggering Credit Card balance makes no sense at all. Bear in mind that $100 can put a real dent in your card debt over time. That's $1200 a year right there, and if you have a $10,000 balance, that additional amount will really accelerate the payoff.

Yes, it does take privation and sacrifice to pay down these debts. And this may mean not eating out as often, getting rid of toys and expensive hobbies, and other cuts in spending. But if you approach this properly, it can be a fun game and one that you CAN win.

And once your credit card debt is paid off, those savings will continue to be in place - and you will be wealthier than before. And that is an important goal to look forward to. Like dieting, there is a reward at the end of the process, if you stick to the plan and keep that reward in mind.

And like dieting, you have to make a life-long commitment to the process. There is little point in losing weight and then gaining it all back, just as there is little point in paying off your debts and then going back in debt again.

So how do you stay out of debt? Using debit cards instead of credit cards is one key. Spending money you HAVE, as opposed to borrowing every month, is a much better idea. Build up your savings so that when an emergency occurs (car repair, burst pipe), you don't have to go into credit card debt to cover the expense.

If you have to get a credit card, get one with a low interest rate and a low credit limit. Once you have good credit, such rates will be offered to you and are not hard to get. Banks compete to get good business, and they will fall all over you for your business, if you are not a deadbeat.

A simple card (not some airline-miles trickery) with a low rate (5-9%) is the best idea. Get one with a limit that you can realistically pay off every month ($1000 or so). Tell the card company not to automatically raise your limit, either. And if they do, politely decline the offer and insist on being put back on the lower limit.

And again, check the balance frequently and setup AutoPay so you don't get rate jacked. Such a card can be useful for sundry purchases or renting a car occasionally and other situations where you may need a credit card. And since you can go-online and pay down the balance in near-real-time, you don't have to worry about "going over the limit" if you need more credit.

The real solution to staying out of debt, however, is to be aware of how much you are spending. Just as in weight management, awareness is the key. If you don't weigh yourself on a daily basis and keep track of how many calories you intake, chances are, you will gain weight. If you keep track of your credit card balances and keep track of your spending, you likely will not go into dent (or further into debt) as you will see the warning signs and take corrective action.

Is any of this "easy"? Of course not. Our society is sick today, in that it is setup to entice people to succumb to their weaknesses - to their lowest instincts. We dangle out the shiny trinket, be it a jet ski, a flat-screen television, or just an attractive-looking meal at a chain restaurant ("where everyone is family!"tm) and entice you to spend on a credit card.

And it is a scheme that works, on a staggeringly huge basis. The vast majority of Americans are in debt, and an alarming number are in debt up to their eyeballs. 70% of Americans carry a balance on their credit cards every month. And I suspect that for most Americans, this balance is at a fairly high interest rate.

Paying interest is non-productive use of your money. Our debt society is based on the idea of constant borrowing. While this makes bankers rich, it does nothing for your own personal bottom line, and in fact, detracts from it.

And at some point in your life, you have to become debt-free. You might as well start now.