Credit Card Payment Pinch
By: Gary Foreman
Dear Dollar Stretcher,
We have a few high interest credit cards. We know now that we were using poor management when we started using these cards and now we are feeling the squeeze from them. Could you tell us how we can pay these cards off? It seems like we never get close to paying them off.
Linda from TN
Linda has discovered a secret. The credit card companies don't want you to pay off your balance. Those balances led to $50 billion in finance charges last year.
And business keeps getting better for the card issuers. All the statistics show that people are relying more on their credit cards and falling deeper into debt. The average balance is now $5,800 per person.
Plus the price that consumers pay for the loans also continues to increase. Even with record low interest rates, people are paying 15% or more for their credit card balances.
Ultimately, to prevent the payment pinch Linda must make payments that are bigger than any new purchases plus this month's interest charges. So to solve the problem Linda can spend less each month, reduce the amount of interest that she owes or write bigger checks.
How can Linda need find a way to charge less each month? A review of her monthly credit card statement could be fruitful. If she finds a series of small purchases or items that she doesn't remember buying, it's time to consider leaving the cards at home. She needs to find a way to identify purchases that could be avoided or postponed.
Next, try to reduce the amount of interest that's charged each month. Linda should contact her creditors. Some will reduce her interest rate if she picks up the phone and asks.
She'll want to pay off the highest interest cards first. If possible, she should move her balance to a lower interest rate card. Only use the card with the lowest rate for new purchases.
Finding a lower interest rate will help, but to really solve the problem Linda needs to see if she can manage to write a bigger payment check each month. Based on a typical minimum payment, Linda can expect to be writing checks the rest of her life! The only permanent way to eliminate the payment pinch is to reduce the balance.
Suppose that Linda and her husband were the average couple and had $11,600 in debt at 18% interest. If she made no new purchases and wrote the minimum payment check for $230 she'd only be reducing her balance by $55!
Fortunately, it doesn't take much to begin to reduce the balance. What would happen if instead of paying the minimum she paid $250 per month and kept it at that level? She'd have the balance paid off in seven years!
So where can she find the extra money? It may not be easy so Linda needs to be motivated. The thought that she's paying $175 each month in interest and not getting anything for it should help. That's money that isn't buying any new clothes, cars or groceries.
Could Linda find $25 a month to increase her payment? Tough? Sure! But a little sacrificial cost cutting could yield $5 a week. That's one coffee per day. Or one lunch out per week. One night out per month. Or the premium channels on your cable TV.
Perhaps Linda has an asset that could be sold with the money going to pay her debt. Or if she has an asset that can't be sold, maybe she can borrow against it at a lower rate than she's paying on her credit cards. Borrowing against her home equity is an obvious possibility. But look beyond the obvious. She might have a life insurance policy that allows for loans. Or perhaps she could borrow from her 401k plan.
It might be time for Linda to consider a part-time job until the card balances are paid off. Although it's tough having a second job, knowing that it's only for a short time makes a big difference.
Suppose that she fails in reducing the balance and it keeps going up. She can expect the card companies to begin to increase her interest rate. Each month the financial noose will get a little tighter.
If Linda can't reduce her balance and is struggling with the minimum payments she might be wise to seek credit counseling. They will negotiate a payment plan with the card companies that Linda can afford. She can expect to give up her credit cards and her credit history will reflect that she sought assistance. But struggling with the minimum payments is a warning sign of upcoming disaster. Unless immediate changes are made things will only get worse.
It's important for Linda and all credit card users to recognize that the minimum payment is dangerous. The first warning sign isn't when paying the minimum is hard. It's when the total that you owe on all of your cards continues to creep up month after month and year after year.
If you can't afford to make more than the minimum payment each month slowly but surely you're heading for even more pain in the future. The only safe credit card balance is one that's shrinking each month.
Gary Foreman is a former Certified Financial Planner who currently edits The Dollar Stretcher website www.stretcher.com You'll find hundreds of articles to help you stretch your day and your dollar.