Feeling overwhelmed by credit card debt and looking for answers? You’re not alone. More than 40% of all US households carry credit card debt, with the average American household carrying a balance of $5,700. When you exclude people who pay their balances in full every month, the average debt is $9,333. And while the average percentage of Americans carrying credit card debt has been on the decline over the past ten years, the average credit card debt amount has been increasing.
The problem starts young too. As if going to college isn’t expensive enough, as soon as a college freshman walks onto campus they are bombarded with credit card offers. Young adults face a series of financial challenges, the biggest among them how to use credit. Unfortunately, the lessons typically come through the school of hard knocks and hefty credit card debt that is easy to get into and nearly impossible to get out of. By the time we’re 30, most of us have hefty credit card debt.
Here’s how to stick it to the robber baron credit card companies in 3 steps rather than live shackled for life to unending credit card debt.
Understanding Credit Cards
But first, to get free you must understand the beast you are fighting. Just how do credit cards work?
It’s a loan. Credit cards are easy to use and the banks like it that way. Every time you use your card, you are taking out a loan from the bank that sponsors the card. That loan comes with interest, usually at demonic rates of 16.99% or more. This is higher than the interest rates of your typical mortgage (currently less than 5%). Some people carry card rates of 25%. That’s insane! For instance, an interest rate of 10% means the bank is doubling their money every 7 years but at 25%, it’s a lightning fast 3 years. That’s money you want to be using, not giving to an already wealthy bank.
In order to get out of debt, we have to understand that using our credit cards is basically taking out a loan to buy whatever it is we’re buying. Do you really want to take out a loan for that bag of Doritos? Because the bank is going to charge you interest on that snack, a really hefty rate too.
Building your credit myth. People think they need credit cards to build their credit but that’s not true. These days we all have student loans, debit cards, car loans, utility bills, etc. All these build your credit just as well as the next. Instead of taking out a credit card, just pay your phone bill every month. Credit cards only help if you pay them off each month. If you can’t do that, you’re hurting your credit.
But you’re here because you have a credit card and you have debt. Here’s how to get out from under them in 3 steps.
Step 1 – Balance Transfer
Unless you have a 3% or lower interest rate (doubtful but check), you should immediately transfer your balance to a new or existing card. You may be shocked that I am advocating opening another card when you struggle with the ones you have. The reason for this is that a balance transfer lowers your interest rate by a great deal, giving you breathing room to pay off your debt. How?
If you’re currently paying 16.99% or more in interest (most are), then your monthly payment is primarily paying off each month’s interest, not your actual debt. You won’t get out from under that debt if $75 of every $100 payment is going to interest.
If you have more than one card, check their balance transfer rates. Most will offer balance transfers at decent rates. Look for 0% for a year or more but watch out for the transfer fee. You may get a 0% transfer rate for a year but they will typically charge you a 3% to 5% transfer fee for the privilege of taking your debt and making money off it. Nice of them, right?
How this really works:
Offer: 0% rate for a year!
Small print: 5% transfer free.
This means you’ll actually pay 5% for the balance transfer. They’ll tack that 5% onto the bill upfront. So if you have a $10,000 balance, the card company will charge you $500 and your balance starting with them will be $10,500 but it will not accrue interest after that for a year so long as you make your payments.
Contrast this with how your current card works at 16.99% or more interest. A $10,000 balance at 16.99% means for the year you’ll have paid $1,699 in interest.
Save yourself the added $1,199 for the year or whatever your exact scenario may be. Do a balance transfer.
Make sure to pay attention to the transfer fee. If the card is offering a 3% rate for the balance transfer but will tack on a 5% transfer fee, that means you’ll actually be paying 8% for the year. There are better cards and rates. Don’t pay over 7% unless there are no other options and try to get between 3%-5% for your total. It’s usually doable.
For People With Only One Card
You can try calling your credit card company and see if they will lower your interest rate to the balance transfer rate they offer new clients. Maybe you’ll get lucky and they’ll agree. Good luck with that but it’s worth a shot!
Probably though you’ll have to open a new card and transfer your entire balance to that card. I recommend Discover Card. They have fantastic balance transfer rates, regularly offering 0% interest for 18 months with a 3% balance transfer fee. That means you’ll get hit with a 3% fee up front ($300 on a $10,000 transfer) but not accrue any new interest for 18 months. That’s phenomenal. If you currently have a card at 16.99% or higher, you’ll be saving thousands of dollars on a $10,000 debt and will probably receive a lower monthly payment.
That’s breathing room.
What to watch for: Depending on your credit score and debt, you may get approved for only part of your debt to transfer to the new card, say $8000 of your $10,000 debt. You might shop around to see if other credit card companies will allow the full transfer. A percentage point or two extra interest won’t hurt too much. If you can’t find anything, take the best transfer offer. You’ll be better off overall.
Transfer and start putting that extra money into your pocket or better yet, use it to pay down your debt faster. Read on for Step 2 and Step 3.
For People with Multiple Cards
If you carry debt on multiple cards, this can get tricky. Ultimately you want to consolidate all that debt onto one card at a low rate. This could take planning and 2 months or so. Why?
Maybe you have a Chase card that allows balance transfers for a total 5% for the year, a Citibank card offering a 6% balance transfer rate and a Capital One card offering a 3% balance transfer rate. You’d like everything to go to Capital One for that sweet 3% rate.
Don’t start transferring your debt over just yet if you currently carry a balance on that Capital One card. For instance, say you have $5000 on Capital One and you want to transfer over $3000 from your Chase card and $2000 from your Citibank card. All your debt will be on one card and the interest rate on your newly transferred debt will certainly be lower than before. However, Capital One will keep the original rate on your preexisting $5000 balance and your payments will first go to it.
This is certainly a step up from where you were. Your payments are consolidated and you’ve effectively lowered your interest rate across your combined debt. But you’re not out of trouble yet.
Here’s how the bank will keep screwing you over. And remember, banks will always try to screw you over.
Your next payment will go to interest first, then your oldest debt on that card. This means your money will go first toward the still 16.99% interest accruing on your original $5000 debt, then to the debt itself. It won’t touch paying off the new debt you transferred in until that $5000 debt is paid off. Plus, if you’re still using the card, you’ll be adding on new debt at the same old Capital One rate of 16.99% or higher and your next payments won’t touch that new debt for years because it tacks on after the balances you just transferred in.
So what you want to do is first consolidate the debts to the card with the second best balance transfer offer. Once the balances are $0 on your other cards, do a second balance transfer to the $0 balance card with the best balance transfer offer. This is how you reset your interest rate and drop those insane rates of 16.99% or higher.
Let’s go back to our example to show how this works. Maybe Chase has the second best balance transfer rate of 5%. Transfer the other 2 balances to it first. Wait until your statement on those 2 cards show $0 and $0 due, then transfer everything from Chase to the best balance transfer rate at Capital One. Now you actually have a 3% rate across your $10,000 consolidated debt and real breathing room. It just took 2 months or so to accomplish. Do your research on the rates because they vary from card to card and those mentioned here are merely examples.
To get out from under crazy credit card debt is a two step process if you have multiple cards but totally worth it in most instances. You could also open a new card and transfer everything over at once, for instance using Discover Card’s 18 month offer. With several open cards, however, you may not be approved a high enough line of credit for all the transfers. Assess your situation to see what works best for you.
Things to watch out for:
Fee rates. Some cards will give you a low fee on the 1st balance transfer but raise the rate on any additional transfer. For example, Discover Card offers 3% for your first balance transfer, then 5% on additional ones. Many cards do this so make sure your largest balance come in 1st so you’re paying less to finance it over time.
Card limits. Another thing to keep in mind is that your current cards may have different limits. For instance, you may like the balance transfer rate for one card but it limits you to transferring in $5000 of your $10,000 debt or consolidating your debt would put you over your current card limit of $8000. Sometimes you can have the card company increase the limit. It’s worth a try.
Step 2 – Stop Adding Debt
You’ve transferred all or most of your debt to a lower rate card. Yay! That’s excellent. Now you won’t waste so much of your precious money on interest and your payments will actually start making a dent in your debt. But you’re not out of danger.
Now you have to stop accruing new debt. You can’t save yourself if you keep self-sabotaging yourself.
This means either not using your credit card for new spending or paying off new spending every month. If you want to keep using your credit cards do so responsibly. If you have multiple cards, I recommend cancelling all but two.
Whatever you do, don’t use the card you just transferred your debt to! Any new spending will go to the end of the queue for payment and accrue the regular card rate, not the balance transfer rate. So that new bag of Doritos will get charged 16.99% for example and be paid off last. Your transferred card is for payments only, not new purchase in order to finally get rid of that debt.
What you want to do is use a $0 balance card for new spending, i.e. the card you just paid off with the balance transfer. Use it for new purchases or autopays AND PAY IT OFF EVERY MONTH. This way you won’t be racking up high interest rates ever again and you’ll be building up your credit, not destroying it. If you can’t do that, you need to cancel the card and go cash and debit to keep from digging a deeper debt hole than you’re already in.
That’s the secret to getting out from under debt. You transfer everything to low, manageable rates so your payments actually pay down your debt faster but you also correct the habit that got you into the mess in the first place.
Step 3 – Bomb Away Your Debt
If you’re only making the minimum payment each month, you’ll be paying off your debt forever. Banks rely on you only paying the minimum so that they can reap tons of interest off you. Therefore they set payments as low as possible to help themselves, not you. You have to pay more than the minimum to get out from under their knives.
And remember, if you’ve done a balance transfer that transfer rate is only good for typically a year or 18 months in the case of Discover Card. Then the rate skyrockets again, forcing you to do another balance transfer somewhere else and you might not find such a sweet rate as the one you originally got.
I can’t stress enough the importance of making large or extra payments.
How large? I’m a big proponent of the 70/30 Rule: live on 70% of net income and invest the rest in money making activities. My caveat is that if you’re in deep debt, then I advocate living on 70% and using the remaining 30% to pay down debt to breathable levels. Read my articles Make Money Work For You – Debt Payoff Option and Did You Know Building Wealth Had These 7 Rules?.
Pretty? No. But doable? Yes. If you want your freedom, your life and your money back, this is one of the best methods.
Credit Card Debt Need Not Cripple You
Most of us learn the hard way about the perils of credit cards. We want the free t-shirt or candy bar at the promotional table, sign up for a card, max it out because we don’t understand the terms, and wind up shackled to the bank for the rest of our lives as we try to pay off the debt we so easily got into.
Getting free takes time but you can do it in 3 steps:
- Consolidate and transfer your debt to one low rate card using balance transfers.
- Stop piling on new debt. Pay off your spending month to month and never carry a new balance.
- Make extra payments.
This isn’t sexy but it’s effective. It’s certainly better than paying 16.99% or higher in interest. You’ll save hundreds if not thousands, have breathing room, and can start using your money toward things that matter, not toward lining the pockets of fat cat banks and their credit card companies.
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