Credit cards are a handy tool for making purchases quickly and easily. They're also nice to have so we don't have to carry large amounts of cash around with us. The downside to this convenience is when it gets to be too easy to use the card and the balance grows to an amount that can't be paid off every month.
In order to avoid paying the outrageous interest charges on credit cards, it's widely accepted that we should pay off the balance every month. That's where the convenience of credit cards becomes a burden, and in some cases, a nightmare.
The Wheel Starts Turning
When we get to a point where the balance on the credit card gets to be too high to pay off each month, that's when the trouble starts. In our minds, we still know that we have to pay off the card each month to avoid paying interest, so we try. We throw every available dollar at the credit card, and at first we feel good that we have put as much money as possible on the card, telling ourselves that next month we'll pay off the rest.
But then reality hits.
While the intention was good, there's an old expression that the road to the land of fire and brimstone is paved with good intentions. Sometime before the end of the month we find that there's not enough money left to make it to the end of the month, and that's when we find ourselves on the credit card mouse wheel. That cycle of dipping back into the credit card and taking back some or all of what we paid to begin with.
Here are three ways that can be used to regain control of your finances and get off that wheel:
1) The 'To-do' List
This approach is especially good if you have more than one card, but it can also work with just one credit card. Make a list of each of the cards you want to get paid down and the minimum payments for each. Make the minimum payment on each card every month and on one card, add an extra $50 to the payment. Do that every month until the card is paid off. When its balance is zero, put the card away, but don't cancel it, at least not yet. More on that later.
Next, take the entire payment you were putting on that first card and add it to the minimum of the next card. Repeat the process, moving the increasingly larger payment over to the next card until they're all done.
Let's suppose you have three credit cards, each with a minimum payment of $50. Put $100 a month on the first card and give the other two only the $50 they require. The point here is to manage the debt and get ahead of it without throwing every dollar at it and running out of money before the end of the month.
Once that first card is paid off , take the $100 payment you were putting on it, add it to the $50 you've been putting on the second card, for a total of $150 and keep doing that until it's gone. By the time you zero the first two and get to the third card, you'll be putting $200 a month it alone and the balance with go down very quickly. So while this process might take a little time to get started and really feel the results, the debt disappears faster as each card gets cleared.
Which Do I Pay First?
I'm often asked which debt to pay off first, the one with the largest balance or the highest interest rate? There are two ways to look at that question. Economically, it's better to pay off the one with the highest interest rate first in order to pay less interest. The other way, and the reason I refer to this strategy as the 'to-do' list, is to pay off the one with the smallest balance. For some people, doing it this way creates a sense of accomplishment and provides a tangible, more immediate result to want to continue.
As mentioned earlier, as each card is cleared off, put it away somewhere safe but don't cancel it right away. Two things that affect your credit rating are total amount of credit available and how much of it is being used. If you close off a card after it's been cleared, your remaining debt will take up more of your remaining credit capacity and make your total usage look worse, even though in reality, you're carrying less debt. If you really want to close off cards, wait until they're all clear and then cut up the ones you no longer want.
2) Using A Line Of Credit
If your credit rating is still in good shape but you're feeling strained by your credit cards, or you just want to pay less in interest, another way of managing the debt and saving some money at the same time is to transfer the balance(s) to a line of credit from the bank. Typically a line of credit will have a lower interest rate than the credit cards and it's one payment, instead of managing multiple payments on credit cards.
With a line of credit, the bank will usually have a minimum amount you have to pay each month. I've seen minimums, anywhere from one to three percent, depending on the bank. That minimum will still likely be lower than the payments required for the credit cards.
Both of the above methods for tackling debt are what I call the do-it-yourself ways of getting rid of debt. They require discipline to stay with the plan until the debts are paid. It's also a good idea to avoid taking on any new debt while getting rid of the old.
3) Getting Help From The Bank
If either of the methods above aren't your style, or if you're in a position where a line of credit is not an option, then a consolidation loan from the bank is another possibility.
A consolidation loan is similar to putting the debt all on a line of credit except the bank will dictate the length of the loan and the monthly payment. These loans tend to have a higher interest rate than a line of credit, but still lower than credit cards interest rates.
Banks are sometimes reluctant to do consolidation loans, so if you have a business relationship with more than one bank and the first one turns you down, try the other one. Consolidation loans are not harmful to your credit rating but once you have one, try not to need another one. In my experience, banks tend to get really reluctant to do a second consolidation loan.
I can speak from first-hand experience that all of the above strategies do work. Long before I helped other people with their money professionally, I made mistakes with my finances and used each of these methods myself at some point. It takes discipline to stay on the road to recovery while getting things back in order but it's worth it.
A Final Thought On Credit Cards
As mentioned at the beginning, credit cards are a useful tool. With the reward programs and points systems available from most cards today, there are great reasons to have them. Personally I believe two cards is ideal, because some retailers might only take one type of card. Be selective. Choose the cards that offer the rewards you really benefit from and if you're going to use them often to rack up the points, keep it at a reasonable level so you can pay them off each month and get off the mouse wheel.
This post is strikingly similar to last week's post, which is a complete coincidence. Chris and I must have been thinking along the same lines. I write about credit cards often because they can be so lucrative for consumers, but also remembering how dangerous they can be if you let your resolve slip is equally important.