For some, getting into credit card debt is a heck of a lot more fun than getting out of it. Others face emergency situations that require large credit card purchases, or worse yet, cash advances. However, there are strategies, like the snowball method, to pay off credit card debt and that do indeed work. Read on to learn how to climb out of credit card debt and then keep it from recurring.
What Is Credit Card Debt?
Credit card debt is money you owe for purchases you made and cash advances you took using your credit card. Unlike a debit card that immediately uses the money in your checking account, credit cards lend you money that you must repay over time. In most cases, it is unsecured debt, which means you posted no collateral to the card issuer before getting the card. (However, folks with poor credit can obtain a secured card collateralized by money in a bank account). It is also revolving debt, meaning you can use and reuse the card up to the credit limit without reapplying for a new loan. The card account remains open for as long as you want it unless the issuer revokes the card for some reason.
If you find yourself with an uncomfortable level of debt, you’re not alone. Check out these pre-pandemic national statistics:
- American workers living from one paycheck to the next: 78%
- Adults without the means to cover a $400 emergency: 44%
- Total U.S. household debt: $13 trillion+
The COVID-19 Nightmare
The COVID-19 pandemic has certainly scrambled the debt picture for many Americans. Of course, there is no way to place a value on a human life. But beyond the death count, we know that millions in this country have exhausted their savings and have plunged into deep debt. The depth of the problem hinges on several factors, including:
- The remaining course of the infection, including whether there are subsequent waves.
- The effectiveness of mitigation and containment efforts.
- The time it takes to develop vaccines and treatments.
- The willingness of individuals to follow social behavior recommendations.
- The number of companies that ultimately go bankrupt.
- The supply of jobs once the pandemic has ended.
- The amount and frequency of financial aid distributed from government sources.
Given all of these variables, it is likely that many households will find themselves in debt, or deeper debt, by the time this nightmare ends. This makes it more important than ever to plan to reduce your debt. The snowball method, or its alternative the avalanche method, can help guide you through the repayment process, as long as you devote the required amount of discipline to the effort.
How Do People Get into Credit Card Debt?
Credit card debt is simply any balance you don’t repay in full before the end of the grace period for the current billing cycle. The grace period is an interval, usually 20 to 25 days, after the close of the monthly billing cycle. Your bill reflects you balance as of the last day of the billing cycle. You then have through the end of the grace period to repay the bill without owing any new interest charges. Any balances carried forward past the current grace period will incur interest until you repay it. The grace period applies only to purchases. Cash advances incur interest from the first day.
There is nothing wrong with credit card debt per se, and is, in fact, one of the great conveniences of credit card usage. It allows you to space out payments over a period of multiple months so that you can buy otherwise unaffordable goods and services. Credit card debt becomes a problem when the total balances on all your credit cards are relatively large compared to your income and savings.
You can run up sizable credit card debt on a single card if it has a high credit limit. Alternatively, you can mound up debt by running up the balances on several different credit cards. Normally, card issuers consider your income, indebtedness and credit score when it establishes the credit limit on your card. If you have a good score, the card issuer may give you a very generous credit limit.
So, in a nutshell, credit card debt builds up when you spend more than you can repay before the next billing cycle. The minimum payment due is but a small fraction of your card balance (typically 5%). If you regularly pay the minimum, your balance can balloon quickly, leaving you mired in debt. In addition, credit card interest rates are notoriously high (after any introductory rates expire), which can double the cost of purchases over time if you make only the minimum payment each month.
How to Use the Snowball Method
The first thing to do is stop using your credit cards until you pay off your debt. As the saying goes, when you’re in a hole, stop digging. Use cash, checks or a debit card for your purchases. Next create a repayment plan. Decide how much of your monthly income you can devote to card repayment and which of your cards (if you own multiple) will receive the bulk of the money. Pay the minimum amount on your other cards until the first one is repaid, and then repeat for the second card on your list.
In the snowball method, you first pay off the card with the smallest balance. After you’ve dispatched that card’s debt, move on to the next card with the smallest balance. Continue until you’re out of debt. Here it is in a simple four-step program:
- Make a list your debts, sorted from smallest to largest. Don’t pay attention to interest rates.
- For all debts but the smallest, make minimum payments.
- For the smallest debt, pay the maximum possible.
- Repeat the process until you pay each debt in full.
The snowball method requires behavior modification that offers the fastest psychological rewards. When you’ve repaid the first debt, you’ve removed it from your life for good. This can give you the confidence to stick to your repayment plan because it lets you pay off the first card relatively quickly. Don’t underestimate the power of momentum – all it takes is the discipline to see the job through to the end.
To see how effective the snowball method can be for you, try using one of the many available debt calculators designed for this purpose. You can use the results to revise your budget so that it reflects the money you save when you no longer have to repay debts.
The Avalanche Method Alternative
The avalanche method entails first paying off the card with the highest interest rate, regardless of balance. Work your way down the card roster until you pay off the one that charges the least. The avalanche method saves you the most in interest and will get you out of debt faster than the snowball method. However, it might seem like it’s taking longer to see progress. If that’s a problem for you, stick to the snowball method.
While the avalanche debt is the most economical, the truth is that there is little difference in the results. The avalanche method will save you some time and money, but the savings are usually minor compared to the impact of getting out of debt. That’s why its more important to pick the method that works best for you rather than the one that saves you the most money.
Other Strategies for Successfully Paying off Debt
Here are some other strategies you can employ to pay off your debt:
- Consolidate your credit card debt: Another method that can work well is to transfer the balances on all your credit cards to a new card that charges no interest on transfers during the introductory period. Note that you’ll likely pay a one-time fee, usually around 3%, for each transfer. Consolidation has the virtue of simplicity, as you won’t have to juggle multiple minimum payments and due dates each month. Some cards have introductory periods of up to 18 months for 0% balance transfers.
- Use a personal loan or home equity line of credit: This is another way to consolidate your credit card debt. You’ll save the balance transfer fees of the previous method, but you might pay that much and more in interest.
- Negotiate a debt settlement: If you owe a lot of money, your creditors might be willing to accept less than full repayment. You can use a legitimate debt relief service to help you.
- File for bankruptcy: This is the nuclear option, because it will ruin your credit score for seven years or longer. Chapter 7 bankruptcy requires you surrender some property. Chapter 13 lets you keep your property. Consult a lawyer and carefully consider the consequences before proceeding.
How to Avoid Credit Card Debt in the Future
Here are some tips to avoid future credit card debt:
- Create and adhere to a realistic budget. Track your spending each month and don’t overspend.
- Use only one card and put away the rest. Don’t close credit card accounts, because it can hurt your credit score. Pay your balance in full each month.
- Use cash or a debit card instead of a credit card. This alone might discourage you from making impulsive purchases.
- Use specific savings accounts for anticipated big-ticket purchases. Save until you reach your goal, then make the purchase with cash.
- Establish a fund to help you avoid debt should an emergency occur. The fund should be large enough to pay three to six months of expenses.
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Keep a Tight Rein on Credit Card Shopping Next Holiday Season
You’ve got about five months before Santa starts showing up on all the TV commercials. If you’ve repaid you debt, you owe it to yourself to keep a grip on spending, despite the avalanche of ads imploring you to do otherwise.
Don’t look upon your credit cards as instruments of the devil. Rather, treat them as useful tools that can be deployed wisely. This requires a little knowledge and a little planning. We’ve laid out seven steps you can follow to maximize the usefulness of your credit card spending during the holidays while avoiding the financial hangover in the new year:
- Your limits vs their limits: Each of your credit cards comes with a spending limit. These limits are not the important ones. The only limit you need to bear in mind is how much you can pay off at the next credit card payment date. Don’t spend more than that amount, and you’ll avoid accumulating credit card balances that cost you interest. Most cards don’t charge interest if you pay your entire balance each month. By avoiding interest, you’ll have more money to spend on sugarplums and candy canes, and you won’t dilute the card rewards with interest payments. Best of all, you won’t accumulate debt and the accompanying financial risks.
- Maximize your rewards: Some credit cards pay rewards on everything you buy. Others pay higher rewards, but only on select types of items, items than can rotate every three months. If you’re taking a holiday vacation, use a card that rewards travel, car rental, hotel stays and so forth. On the other hand, if you like to give frequent holiday parties, use a card that rewards you for supermarket shopping. If you don’t have a card that sufficiently rewards you for the types of purchases you plan this season, apply for one that does. Also, be on the lookout for special holiday promotions. Some cards may offer double rewards during the holidays, or maybe extra cash back for department store purchases.
- New cards: As we alluded to, your old cards might not be optimal for the holiday season. Maybe they don’t have worthwhile rewards programs, or the limits are too low, or they charge too much interest. You want a card that has a low fee, (including zero fees for the first year), a reasonable credit limit and a generous reward or cash-back program. Card comparison websites are a good resource for finding out about which cards offer the best ratio of rewards to fees, as well as alerting you to special sign-up bonuses for the holiday season. Opening a new credit card might cost you a few points on your credit score, so don’t open too many. Also, don’t open a new account if you plan to buy a car or home in the next several months, because you’d like the highest credit score you can get before making a big-ticket purchase.
- Be skeptical of charge cards: Department stores and boutiques love signing you up for their exclusive charge cards during the holidays. Normally, they offer some good-looking rewards, such as half off your first purchase, to entice you into applying for their card. But before you jump, do a little research. Find out how much they charge in fees, their credit limits, and their interest rates. Do they offer cash-back or reward programs? Also, consider how likely it is that you’ll ever use the charge card again. Remember, getting a new card with a low limit can hurt your overall credit utilization ratio (debt balance/credit limit), and ding your credit score. It might be worth it if you regularly shop at the store.
- Enjoy the perks: Many credit card issuers offer special perks that can really be valuable over the holiday season. For instance, your card may offer a price protection plan: If the item’s price is reduced over the next little while, you can receive a partial refund on your purchase price. That’s great for holiday shopping, because you can shop early without sacrificing the benefit of late sales. Also, if you are travelling this season, check to see if your card offers benefits like luggage loss protection or automatic collision damage waiver on a car rental. Look also for fraud protection, extended warranties, and longer gift-return timeframes.
- Check out shopping portals: Do you know about these? They are websites run by card issuers with links to all the major online retailers. These portals usually offer exclusive discounts, additional cash-back rewards and/or extra points or miles. For anyone who shops online during the holiday season, it makes sense to first visit shopping portals and see how much extra you get for using them. After all, triple your cash back can be pretty handy during the holidays.
Tap into apps: Most major credit cards come with smartphone apps you can download. These apps let you keep track of your spending as well as the cash-back or other rewards that you’ve racked up so far. You can use the app to redeem your rewards on the spot. If you have multiple cards, you can use an e-wallet app to handle all of your credit cards, and to enable payment by phone instead of by card. Some apps even tell you which of your credit cards will provide you with the biggest reward for a particular purchase.