What is credit card debt

What does Credit Card debt mean

Credit card debt is a type of consumer debt (personal debt), it is accrued as a result of personal consumption (Household spending e.g. shopping). It is unsecured, expensive, and has a revolving element to it- It is indefinite, As long as you pay the minimum amount, you can continue borrowing more until you hit the limit.

Credit card debt is a sub-optimal loan- its revolving nature, coupled with a high-interest rate can easily plunge you deeper into debts (Peak debt). This leads to a feeling of being overwhelmed as soon as you max out the card and start struggling to catch up with payments.

How does Credit Card debt work

It’s a revolving credit-meaning you don’t have to pay off the whole loan and close off the account, rather you pay off a minimum balance and the rest of the balance is rolled off to the succeeding month.  After 60 days of the grace period, any balance not paid off is charged interest. Please bear in mind, that credit card debt is unsecured debt, hence interest is higher than the interest charged on other loans.

How do you get there

• Shopping Sprees

  This occurs when you purchase an unplanned item knowing very well that the payments are not likely to be cleared within 60 days, and the minimum payments will bear lots of loads on the current paycheck! If you have to make a huge purchase, always consider alternatives. Avoid short-term solutions, and work towards financing yourself on whatever you like.

• Minimum Payments

  The rule of thumb is that any purchases made on the card should be settled at the end of the billing period, else with compounding and possibly penalties, the debt grows. Settling for minimum payments is an indicator you are spending more than you can afford. The credit card limit is not extra cash, try to live within your means.

• Cash Advances

  The rule of thumb is to avoid taking cash advances. This is because it’s the most expensive way to access ash as the interest and charges are astronomical. Secondly, cash advances do not have a grace period-billing is immediate and not at the close of the billing cycle.

• Prime Rate

  The prime rate affects the calculation of APR. There is usually a ripple effect when Fed raises or lowers the bench rate. If you are making minimum payments that barely cover the interest and the balances, any increase will compound the debt beyond your ability. The rule of thumb is to pay off full balances, or at least make substantial minimum payments that cover the interest and part of the principal, and work towards clearing the full balance in big enough installments

• Penalty rates

  Penal rates can go as high as 30%- higher than the normal credit card APR. This is applied if you are 60 days late on your payment. To put things into perspective, a Penal APR of 30% on a balance of $1,000 is $300! If you getting charged this, chances are you are already in some sort of a hole, this steep interest rate can only dig you deeper! To compound your problems, some cards charge this rate indefinitely on the first missed payment!

How much debt is too much

Are you overwhelmed

There is no golden number. However, you are in trouble if check any of the boxes below;

• Aggregate credit card Credit Utilization level is more than 30%
• You are utilizing more than 40% of your paycheck to clear credit card debts
• Your minimum payments are not covering interest charged on your credit card
• You are late on your payments- penalties and penal rates do compound balances very fast!
• You are actively considering filing for bankruptcy

These are signs your debt is getting out of hand

• Your Credit Card always has an outstanding balance

  This is a clear indicator that you are living way beyond your means and you are using a credit card limit to finance the deficit. Paying more than 40% of your paycheck on credit card payments points to debt. Make a plan to cut unnecessary expenses and work on your savings to cover rainy days.

• Late Payments

  Are you struggling to clear minimum payments? If minimum card payments have a lower priority than the purchase of basics like groceries and other bills? Then you are in credit card debt. Make a budget and commit to the budget.

• Unable to come out of debt

  This usually means you are using one card to pay for another card. At this point, you are beyond using a paycheck as a payment source (another low in life). You can’t wish a debt away, the only solution is to prioritize debts and commit to paying Create a realistic budget and go on the offensive by negotiating with the creditor.

• Relying on Credit Cards for subsistence

  If you are using the card to survive, and are unable to cater for day-to-day bills without your credit card, then you are in debt. You need to cut expenses. A huge debt weighing on your shoulders can change your outlook on life and even your attitude towards paychecks.

• Paying off Credit Cards than making savings

  If you are always in the rat race to pay off minimum payments, you don’t seem to have enough for savings, then you are deep in the hole. Make a plan to clear off the debt to clear room for savings. This involves lifestyle changes that go beyond the cosmetic.

Does Credit Card debt affect your credit score

Yes, it does– and can easily wreak havoc on your credit score. When you maxed out your limit, the assumption is you are living way above your limits. Late payments will make a bad situation worse.

Don’t charge more than you afford to repay at the end of the billing period. Contrary to popular advice, carrying debt does not improve your credit score, rather the utilization of the credit is what counts.

A credit utilization score of over 30% will hurt your credit score- remember this aggregate total on all cards held. The trick is to increase your credit limit so that you don’t go beyond the recommended 30% score.

Getting out of Credit Card debt (paying off your Credit Card debts)

While Scaling out debt looks like an impossible task, following a certain fiscal regimen of addressing the debt will work out results faster. Make no mistake, you will need to make adjustments in your lifestyle to free off some cash. Also, try to make some extra cash and increase your earning power.

Below, please find 4 easy tips to clear off Credit Card debts.

Paying off Credit Card debts with the highest rate first.

You will rank all your loans and set your focus on the loan with the highest rate. Make major changes to your current lifestyle, any dollar saved can accelerate current payments. This is a multi-throng approach, as savings in lifestyle changes can stop the increase in current debts and the savings accelerate payments of high APR debts

Snowballing Credit Card debts.

This strategy involves ranking your debts from the largest to the smallest. The priority will be on smaller debts that you can tick off easily. Any extra cash freed is fed into the next debt in the line hence a snowball effect. Do not underestimate the psychological boost you will get from crossing off the debt from the list. This, together with lifestyle changes can easily bring your debts under control.

Consolidating Credit Card debt.

This is a personal finance strategy under a debt management plan where you combine multiple credit card balances with different payment dates and different APRs into one balance under one card payable in monthly installments. It’s only advisable if the new card has a lower APR compared to the different cards already held. Essentially this reduces the cost of the debt hence a shorter payment period.

4 Tips for Consolidating Credit Card debts

• Apply for a Credit Card balance transfer

  You can transfer into a credit card with better terms and an introductory 0% APR. This will effectively buy you time to reorganize your finances (around 12-18 months). The catch here might be the balance transfer fee (3-5%), make sure it doesn’t negate the gains made in 0% APR. Secondly higher APR will probably kick in after the 0% APR period expires. Thirdly the option is only available before things go south and your credit score suffers.

• You can apply to combine the current Credit Card debt with another personal loan.

  The lender of the personal loan will pay off directly your credit card debts and incorporate the balance into your personal loan. The plan mostly doesn’t affect your monthly installments hence less harmful to your credit score.

• Take a loan from your 401(k).

  This is an employer-sponsored retirement scheme where you save towards your retirement. You can dip into these savings for quick cash, payable monthly up to a term of 5 years without affecting your credit score. This is highly not advisable as it affects your retirement plans and the loan becomes payable immediately (The latest-final tax day of the next year) else you trigger taxes and penalties on the unpaid balance.

• Refinance the debt using one time Home Equity Loan or Home Equity Line of Credit (HELOCs).

  Home Equity Loan is best for one-time cash needs, while HELOCs which is a revolving funds hence best when you will be needing cash at different points in time. The advantage is that they have lower and fixed APR when compared to other unsecured loans. The major con is that they place an additional lien on your home (more risk of foreclosure). It’s not direct access to cash, you have to be eligible hence dependable on the value of your home as well as your creditworthiness.

Go for Debt Relief.

This is the last resort measure, basically, you have run out of options to pay off your debts. It’s not for everyone as it comes with serious consequences. Consider this only if you feel you can’t pay current debts within 5 years, especially when the monthly payments of unsecured debts are more than your paycheck. Declare bankruptcy and start afresh. At this point, nothing matters, not your credit score but peace of mind and a chance to start afresh.

Bottom line

When in financial distress, do not delay or miss payments on secured loans so as to focus on unsecured loans, you could easily lose your home or car and sink deeper into a financial crisis. Make a quick plan, Pay according to your priority, not the lender who is harassing you the most!