How to Manage Credit Card Debt

Credit cards are a convenient way to pay for goods and services, but managing credit card debt can be challenging.  Let’s consider the benefits of using a credit card, compared to cash:

Benefits of Using a Credit Card

  1. Unlike cash, credit cards can be replaced easily when lost.
  2. A credit card bill provides a useful written summary of purchases.
  3. Credit Card rewards programs help you accrue points toward travel and merchandise.
  4. You can purchase items when you don’t have enough cash.

Now let’s look at the negative aspects of using a credit card.

Cons of Using a Credit Card

  1. People generally spend more money when using credit.
  2. You will pay more for the same items when using a credit card and paying interest on your balance.
  3. High balances and missed payments contribute to a low credit score, which can have a negative impact on future borrowing, insurance rates and employability (more on this later).
  4. You can purchase items when you don’t have enough cash.

As with any financial decision, you should consider the pros and cons of using a credit card.

Credit Card Terms You Should Know

  1. Annual Percentage Rate (also known as APR)
  2. Additional fees (origination or “setup fee”, annual fee, etc.)
  3. Repayment term

Using Your Credit Cards To Pay For Everyday Items

Using your credit cards to pay for everyday items could be a sign that you need to get your budget under control brought to you by Money Minute.

Understanding Your Credit Card’s Annual Percentage Rate (APR)

The Annual Percentage Rate or interest charged on a credit card balance typically ranges from 0 to 30%. For example, a credit card balance of $100 at 23% APR will cost you $23 in simple interest each year.

Alison, John and Pete all bought new computers for college by charging $1000 to their credit cards. Like most consumers, they were unaware of their APR. Using an online credit card calculator, we can see that if they pay only the monthly minimum payment on their balance, the following will happen:

Alison’s APR: 9% – Alison will spend 7.5 years paying a total of $1373 for the computer.

John’s APR: 18% – John will spend 9.4 years paying a total of $1923 for the computer.

Pete’s APR: 27% – Pete will spend 10.8 years paying a total of $2544 for the computer

We all hope that it will not take 10 years to pay off a computer. Yet statistics show that a significant percent of Americans pay only the minimum payment on their credit card. With a mid-range interest rate of 18%, paying only the minimum payment means adding both time and money to the real cost. Enter your current credit card debt and APR into this online tool to find out how reducing your debt can save you hundreds, if not thousands of dollars.

How to Reduce Credit Card Debt

In order to save money (and years of payments), consider the following alternatives:

  1. Comparison shop for a credit card with a better interest rate
  2. Pay MORE than the minimum balance to shorten the length of the repayment period
  3. Wait to purchase a computer with cash, using the school computer lab in the meantime
  4. Seek credit consolidation to reduce the number of payments you make each month
  5. Use an alternate borrowing method with a lower interest rate (student loan, secured bank loan)
  6. Purchase a functional, minicomputer for $250
  7. Purchase a functional, used computer for $150

There are many ways to accomplish purchasing your needs and saving money at the same time. Always consider alternate options before charging purchases on a credit card, especially when you do not have enough money to pay off the balance when the bill comes.

Credit Card Nightmare

Let’s assume that Alison purchased her $1000 computer on the credit card in the above example. She qualified for the 9% introductory rate. She left the dorm during winter break, forgetting to forward her mail and missed making her December credit card payment. Based on the above terms, what would be the consequences of making a late payment?

Penalty APR of 28% (for a minimum of 6 months): $140 in additional interest

Late payment fee of $29

One late payment will cost Anna approximately $169, or almost 17% of the computer’s purchase price. Moral of the story: If you carry a balance, late payments will cost you big money.

If you already have a credit card, you can find out what your APR and fees are by examining your monthly statement. Your statement will list your purchase, balance transfer and cash advance APR, as well the total amount of fees you’ve

Shop Around

If you have a credit card and are paying high interest rates and fees, you should shop around online for a better deal. Check out Consumer Action’s Credit Card Survey to compare cards. Your] payment patterns should dictate the terms that are important to you. For example, if you pay your balance in full every month, the APR is not as important as a low or no annual fee. Conversely, if you always carry a balance, the APR is very important since you will be accruing interest charges each month.

Credit Card Incentive Programs: Are They Worth It?

John did some ‘back to school’ shopping in a department store. At the register, the clerk asked him if he’d like to save 10% by signing up for a store credit card. John figured that he’d save about $15 by filling out the form, so he opened the card.

Alison received an offer in the mail for a “rewards” credit card. For every 25,000 points, she’d receive a free airline ticket. The annual fee on the card is $50.

Do these scenarios sound familiar? Have you ever opened a credit card account in response to an incentives program? Are these programs worth it to you?

Credit Card Reward Program Pros

  1. Save money on purchases
  2. Receive coupons, store notifications and other communications from stores where you have a credit card
  3. Receive merchandise and travel rewards based on total points accumulated

Credit Card Reward Program Cons

  1. The more credit card accounts you have open, the harder it is to track terms (APR & Fees) on all of them.
  2. You may be more likely to miss a payment because you have more bills to keep track of.
  3. If you open multiple accounts and maintain high balances on them, your credit score may be negatively impacted (high debt-to-income ratio. Studies show that people generally spend more money when they ‘pay with plastic’ than when they carry cash. This may be more money than you save through purchase discounts and rewards programs.

Think about Alison. With a $1000 computer purchase, she was able to accumulate 4% (1000 points) of the points she would need for a free airline ticket (25,000 points or a $250 value). With one late payment, she lost $116 (50% of the actual price of a free plane ticket). Additionally, she may need to use this credit card for 5 years before accumulating 25,000 points. That’s $250 in annual fees – about the same price as a plane ticket.

If you decide to open up a credit card, you must examine the credit card terms from multiple companies and comparison shop. All cards are not equal. Ideally, find a credit card with no annual fee, a low APR for purchases, and low fees.

If you carry a credit card balance, you should re-evaluate your terms by reading your monthly statement and then shop around for better terms by doing online research. Make it a goal to carry debt at the lowest possible interest rate, and pay it off as fast as you can. Just remember that the longer you carry debt, the higher the price tag moves on all of the items you purchased with your credit card.