With consumer debt at an all-time high, I figured now is an appropriate time to write about credit card debt, why it’s bad, and how you can get out of it.
Why it’s bad
All-in-all, there are only two reasons why credit card debt is bad.
- It’s expensive – If you carry a balance on your credit month-over-month, you are charged interest on that balance. Most credit cards have an interest rate of 15%+. It also “robs” you from being able to save more money, as you are spending it on servicing that debt.
- It can hurt your credit score – One of the biggest factors in calculating your credit score is your credit utilization rate. It’s represented as a ratio. Amount of credit used divided by the amount of credit available. Higher utilization negatively impacts your score. That said, if you have a large balance outstanding and it’s more than 30% of your available credit, it’s going to hurt your score. Not to mention, if you opened a card recently, that could bring your average credit age down, which is also bad for your score.
If it’s so bad, how do you get out? (Article about things that are bad for your score)
Credit card balance transfer
With this method, you have to take the good with the bad. Many credit card companies offer a 0% APR on balance transfers for a certain period of time. Some offer 0% for 21 months!
However, there usually is a balance transfer fee (typically 3%) of the incoming balance. Also, opening a new credit account will lower your average credit age, which we said earlier, is bad.
The good part is you now have some/all (depending on how much debt you have) of your high-interest debt in a no-interest account. This could really help put a dent in your outstanding debt.
Be advised that the 0% rate is temporary. If you don’t pay off your balance within the allotted time, that interest rate will shoot up.
*Terms and eligibility will differ depending on your credit score/report.
Using the debt avalanche method “saves you money.” That’s because the strategy revolves around paying off the highest interest card ASAP.
You pay the minimum on all of your other balances and pay as much as you can towards the card with the highest rate.
Once that card is paid off, redirect the money you were using to pay it off towards the card with the next highest rate, and so on.
I said it “saves you money” because the higher the rate, the more costly it is to service the debt.
The snowball method involves low balances. I believe this one is more effective because it’s better from a psychological perspective. The avalanche method is better from a financial standpoint.
With the snowball, you pay the minimum towards all the other debt and pay as much as you can on the card with the lowest balance. Once that card is paid off, use the funds from the payments on that card towards the card with the next lowest balance.
This method gets you a win right away by paying a card off. The impetus for this strategy is to motivate you to keep pushing forward because of that immediate win.
Not going to lie, but this one is my least favorite because you’re only slightly improving your circumstances.
When you get a personal loan, the bank/credit union/financial institution issues you a loan to pay off all of your credit cards.
You’re left with one loan and one payment.
However, the rate you receive for that loan is important because if it isn’t lower than the average APR on all of your credit cards, then it doesn’t make [financial] sense.
The rate you receive, like the balance transfer, depends on your credit score. Also, like the balance transfer, you’re opening a new credit account, and that lowers your average credit age.
Negotiate lower rates
If you want a little assistance paying down your credit cards, call the credit card company and ask if they can reduce your rate. If you’ve been a loyal customer and a good (100% on-time) payment history, they’re more likely to oblige.
It also helps to explain your situation and stress your intention for paying your balance off.
Benefits of a credit card
Credit cards can serve a valuable purpose for disciplined spenders. Some offer great rewards, like travel miles, cashback, as well as others.
It also shows spending and payment history, which is what the credit rating agencies want to see. Especially, if those payments are on time.
They can be dangerous, however. If you’re planning on opening/using a credit card, make sure you’re responsible and don’t let your balance get out of hand.
To obtain a low balance transfer credit card you should shop around. Use aggregators to find the best possible deal – and if necessary, change your card provider again after 12 months to obtain a repeat deal.