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There are few things that cause financial distress and anxiety more than a plethora of credit card debt with high interest rates.
Millions of Americans of all income levels carry large balances on credit cards that charge very high interest rates. According to Federal Reserve data, the average annual percentage of cards issued by commercial banks was 16.45% at the end of last year, and the rates charged by stores’ credit cards can be more than 20%.
While card balances have fallen significantly from a peak of $927 billion at the end of 2019, they remained high at $841 billion at the end of the first quarter and could continue to grow.
“Credit card debt remains a huge problem,” said Rachel Gittleman, director of financial services for the American Consumers Association. “There were some payments at the start of the pandemic, but I think the balances may start to rise again with increases in the cost of living.”
If you’re struggling to make minimal payments on credit card balances, there are options to help you reduce the amount you owe and/or reduce the amount of interest you pay on debt.
However, there is no magic bullet for high debt. The solution starts with changing your behavior.
“The only long-term solution is to fix your spending habits,” said Summer Reed, financial advisor and senior education director at the Association for Financial Advisory and Education Planning. “Nothing will work unless you stick to a reduced spending plan.
“You should get your spending below your income level.”
A credit card balance of $10,000 with a 20% interest rate costs you $167 per month and this just ensures that your balance does not increase. To start paying off the debt balance, you need to do more.
There are two primary aspects to controlling your spending; Not using your credit cards and formulating a sustainable budget that includes paying off card balances.
On the first front, Red suggests people cut off all but one of their credit cards. Don’t cancel accounts because your credit score will suffer
If you’re still itching to use your card, put it in the freezer. “It takes about three hours for a credit card to melt and be ready to use,” Reed said. “This gives you time to think about your purchases.” Use the card only for purchases that you can pay off at the end of the month.
Working with a certified financial advisor can help you learn your best options.
Rachel Gittleman
Director of Financial Services Liaison at the Consumer Federation of America
On the second front, you will have to make some sacrifices to start reducing your debt balances. It could mean downsizing a house or apartment, selling a car, or cooking at home more. It is essential that you draft a budget that details all of your expenses and income to determine where you can cut back on spending and pay off debt.
Gittleman recommends getting help. “Every consumer’s financial situation is different,” she said. “They have different debts, different spending habits, and different things of value to them.
“Working with a certified financial advisor can help you discover your best options.”
Regarding debt repayment strategies, there are two basic repayment models. The first method — called the snowball method — pays off smaller debt balances first to give consumers some momentum. The idea is to pay the minimum amounts on all debt balances to avoid late fees or high interest fees, and then apply the rest to your smallest debt balance.
When you pay off that balance, you move to the next smallest balance. “The drive to pay off a very valuable debt,” Reid said. “Being able to see that can be a powerful motivator for people.”
If you don’t need positive reinforcement, you can focus on the debt with the highest interest rate first. In the long run, the so-called avalanche method – from the highest to the lowest – will save you the most interest charges.
While changing your spending patterns is the only thing that will sustainably get you out of the debt gap, there are other steps you can consider that may reduce the amount you owe or reduce the interest you incur. Here are four procedures to consider:
- Contact your credit card company to see if you can reduce the amount you owe or lower the interest rate on the debt. Do not drive the possibility of a personal declaration of bankruptcy but explain that you are unable to pay your existing balance under the current terms. Credit card companies want you to get paid and may offer some comfort in making sure they do.
- It may make sense to transfer the credit card balance to other cards that do not offer any interest for a certain period, but they are not free. They may offer 0% interest for six or 12 months, but they usually charge 3% to 4% of the balance up front. If you don’t pay off the debt during this grace period, you won’t be better off at the end of it.
- Consolidating your higher interest credit card debt and paying it off with a personal loan at a lower rate can significantly reduce your interest expense. Most likely, it should be a home purchase loan if your credit profile is poor. The downside is that if you don’t control your spending, your home could be in danger down the road.
- If your debt is very large—often due to medical expenses, which are a major factor in 60% of personal bankruptcies—bankruptcy may be your best option. If most of your debts are unsecured, such as credit card balances and medical bills, bankruptcy can give you a fresh start. Talk to a financial advisor and bankruptcy attorney before taking this step.