Credit card debt has become an increasingly big problem for many Americans. We owe an average of $13,177.75 per household just in credit card debts. But that’s only an average. The fact is that many individuals owe $15,000, $20,000 or even more on their credit cards. Here’s an example of what this amount of debt could mean. If you owe $20,000 at an average of 16% interest, and paid $400 a month on your credit cards it would take you 83 months to pay them off and would cost you $13,177.75 just in interest alone. And that’s assuming you charge exactly nothing on those cards for the whole 83 months (nearly seven years).
We’ve become a nation of credit card junkies
The fact is we’ve become a nation of credit card junkies. As of July of this year, there were 1,895,834,000 credit cards in use here in the U.S. That’s nearly two billion credit cards. And wee have an average of 3.75 credit cards per person. Given these numbers it’s no wonder why many Americans are struggling with their credit card debts.
It’s borrowing from your future
The really destructive thing about using credit cards is that it means borrowing from your future to pay for things today. There’s an old saying that if you want to dance, you’ll have to pay the piper. In the case of credit cards what this means is if you want to buy things today you can’t really afford by using credit cards, you’re basically borrowing money you’ll have to repay some time in the future. And when that some time rolls around, you’ll have less money available to pay for the things you’ll want then.
The dark side of compounding interest
If you don’t pay off your credit card balances every month, you’ll soon run into the power of compounding interest. If you’re not familiar with this it’s when the interest you owe on a credit card debt is added to your balance so you end up paying interest on the interest. Here’s an example of how this works. Let’s say you have a credit card with an interest rate of 20% monthly on your unpaid balance. If you factor this into an unpaid balance of $1000 at the beginning of the year this will turn into $1200 in debt by year’s end. Multiply this by 20 (an unpaid balance of $20,000) and you will see how much you could be hurt financially by compounding interest.
Shred them but don’t close your accounts
According to a recent study done by the National Foundation for Credit Counseling about 20% or one in five people live without credit cards. This means it obviously can be done. So if you want to get your finances back under control, you need to shred all your credit cards. But don’t close the accounts. You may eventually want new credit in the form of an auto loan or mortgage. When you apply for new credit the first thing your lender will do is check your credit score, which is made up of five components. One of the most important of these is your debt-to-credit ratio as it accounts for 30% of your score. This ratio is calculated by dividing the amount of debt you have by the total amount of credit you have available. For example, if you have $10,000 in available credit and only $2000 in debts, your debt-to-credit ratio would be 20%, which would be excellent. But if you were to close your credit cards your available credit might drop down to something like $2000 and your debt-to-credit ratio would be 100% and that would have a dramatically negative effect on your credit score.
How to live without credit cards
Despite what you might think, it should be fairly easy to live without those credit cards. While you have to basically pay cash for all of your purchases, this could be in the form of a check or debit card. You could also purchase prepaid credit cards or secured credit cards and use them to pay for your purchases.
Before you trot off to get either a prepaid or secured credit card, you need to know their differences. A prepaid card is just that – you deposit money in advance and then use the card to pay for your purchases until your balance reaches zero. At that point, you can then either add more money to the card or simply throw it away and get another one. A secured card is different in that you make a cash collateral deposit usually $300 or $500 – that gives you a line of credit, which usually will be a percentage of your deposit or possibly the full amount. You then make monthly payments on your balance just as you would with a standard credit card. Also like a standard credit card if you fail to make your payments on time you will be charged a late fee and there will probably also be a fee for any over-the-limit transactions. However, unlike a regular credit card if you exceed your balance or default on your payments you could lose your deposit and your account would likely be closed.
How could you pay cash for all your purchases?
If you’ve been living on a steady diet of credit card usage the idea of shredding your cards and paying cash for everything can be scary. But it shouldn’t be. The secret is to start tracking your spending so that you can develop a budget. There are a number of apps available that make tracking spending just about brain dead simple. One of our favorites is Mint.com. It’s free and not only tracks your spending but will automatically divide it into categories such as rent or mortgage payment, groceries, utilities, medical bills, clothing, entertainment and so forth. You could use this information to create a budget and Mint.com we’ll even help you stay on it. In fact, if you overspend in any of your categories, Mint will send you an alert via email.
Once you’ve had some experience with your budget, you should be able to find areas where you can cut your spending. Most people divide their budgets into two major categories – fixed expenses and discretionary expenses. You may not be able to do much about your fixed expenses such as your rent or mortgage payment, auto loan and utilities. But you should be able to find areas in your discretionary spending where you could make cuts. Take groceries as an example. If you focus your attention on cutting your food costs by careful shopping and the use of coupons, you might be able to cut those costs in half or better. This will free up money you could use to pay down and ultimately pay off those credit card debts.
The snowball strategy
If your goal is to get those credit card debts paid off, one of the best ways to do this is what’s called the snowball strategy. This means ordering your debts from the one with the lowest balance down to the one with the highest. You then focus your attention on paying off that debt with the lowest balance while continuing to make at least the minimum payments on your other debts. When you get that first debt paid off, you will have extra money to pay off the debt with the second lowest balance and so on. If you’re wondering why this is called the snowball strategy it’s because the idea behind it is that as you pay off each of your debts, you will gain momentum to continue paying them off just as a snowball rolling downhill gathers momentum.
Note: If you’d like to know more about how to snowball your debt, here’s a short video with more information …