The Truth About Credit Card Debt
In This Chapter
- Avoiding credit card debt in the first place
- How credit card debt accumulates
- How long it can take to pay off credit card debt
- Understanding how debt settlement works
- Ensuring your card stays safe
Many Americans have a problem with spending too much. Nearly 1 million of us file for personal bankruptcy each year, and poor or excess use of credit is cited as the number-three reason, right after medical expenses and job loss. The difference, of course, is that although high medical bills and job loss might be unavoidable, excess spending, for most people, is not.
Many people, despite working extremely hard, just can’t make ends meet because they don’t earn enough money. Other people make plenty of money but still end up with credit card debt that gets them into trouble.
In this chapter, we look at exactly how credit card debt works and steps that might help if you find yourself in trouble.
Resisting the Urge to Spend, Spend, Spend
An important thing to remember about credit cards is that just because you have them, doesn’t mean you have to use them to rack up a lot of debt for stuff you don’t need.
As gratifying as it might seem to throw a bunch of bags in the backseat as you leave the mall, your spending will catch up with you at the end of the billing period.
Knowing When to Use Your Card
Say you’re driving 4 hours to visit some college friends for the weekend. You’re about two thirds of the way there when you notice your car’s temperature gauge is on the rise. The needle keeps nosing up, and pretty soon you notice little wisps of steam coming from under the hood. You pull over and call roadside travel assistance, which dispatches a tow truck that gets you and your car to a nearby service station.
It doesn’t take the mechanic long to figure out that there’s a hole in your radiator, and when he starts talking about replacing hoses, the dollar signs begin stacking up in your mind. You finally get the bill for the tow and the repairs—$347.93. You only have $40 in your wallet, and you’re still hoping to get to your friend’s house for the weekend.
This definitely is a situation in which you should use your credit card and be grateful you have it. Emergencies such as this are when credit cards are at their finest.
Dollars and Sense
Credit cards are necessary if you run into an unexpected emergency expense, so don’t leave home without one if you’re traveling.
They’re also great when you shop from a catalog or online or want to secure a hotel reservation, a car rental, or a plane ticket.
Sometimes Cash (or Debit) Is King
At other times and places, though, you should forget you even have a credit card. Many financial advisers will tell you to never use a credit card to buy anything that depreciates. This includes clothing, shoes, gas, restaurant meals, groceries, and so on. It’s better to pay for these expenses with cash or a debit card to assure you won’t run up a credit card bill you won’t be able to pay off at the end of the billing period.
Of course, there are exceptions to this rule. For example, say you’re on vacation and see a cool pair of sandals on sale you just love. If you pay cash for the sandals, you won’t have enough cash for the rest of the vacation, so you buy the sandals and put the charge on your credit card. That’s fine, as long as you’ll be able to pay off the charge when the bill comes in.
As mentioned earlier, an increasing number of people are using cards to pay for nearly everything, either as a convenience or to rack up reward points. If you’re not absolutely certain you can pay off your bill at the end of the month, however, that’s not a good idea. No matter how disciplined you think you’re going to be, it’s just easier to spend with a credit card than when you’re paying with a debit card or cash.
Here’s a generally good rule to follow:
Don’t use a credit card to pay for something that will be gone or over when the bill comes.
When using a debit card instead of a credit card, remember to keep track of how much money is available in your account. If you have $500 in your checking account and just wrote checks totaling $450 to cover monthly bills, you’ll still be able to access $500 with your debit card until the checks clear. The problem is, if you use your debit card to pay for $90 worth of groceries before those checks clear, you’ll come up $40 short.
Money Pit
A debit card may not offer the protection a credit card does for items you purchase that are never delivered or are defective. If you pay for something with your debit card and you have a problem with the item, try to resolve it with the merchant. If you can’t, contact your debit card issuer for advice.
The same is true with mobile wallets. Here, you carry your credit or debit card information in a digital form on your smartphone, smartwatch, or tablet and use the device instead of an actual card to pay for purchases. It’s easy and convenient, but you still need to have funds available to pay for your purchases. If your mobile wallet app is linked to your debit card, you must have sufficient funds at time of purchase. If it’s linked to your credit card, you’ll get the bill at the end of your billing cycle.
Using a mobile wallet is convenient, and many wallets offer rewards and discounts to encourage you to use them. If you switch to mobile pay, however, check out what security measures the wallet provides to protect your card information. Also, some varieties of mobile wallets only work with certain types of devices, so you’ll need to find one that is compatible with the device(s) you have.
Understanding Credit Card Debt
As a nation, we owed a collective $721 billion in outstanding balances on credit cards in 2014, according to the Federal Reserve. The problem with credit card debt is that it often comes with high interest rates. The average rate is around 15 percent, but it’s not uncommon to have a rate of 17 or 19 percent or even higher.
So if you owe a lot of money on credit cards and you don’t have enough money to pay off your debt, the credit card company is going to charge you interest.
If you have a credit card, you get a monthly statement that tells you where you shopped and how much you spent. The dinner and drinks at that fun restaurant near the beach. The groceries you charged at Trader Joe’s. The gas you bought at the corner station. The tuxedo you rented from Men’s Wearhouse for your friend’s wedding, and yep, the flowers you bought your mom for Mother’s Day—it’s all spelled out on your statement.
The statement also shows you your new balance and a minimum payment, which is the least amount you can pay on your next due date. You’ll probably have between 21 and 25 days from the time you get the statement until the date by which you must make a payment.
If you don’t pay off your entire balance, you’ll accrue interest on your average daily balance. That interest is added to the amount you still owe on your balance. That amount actually ends up increasing daily because the balance of your account is multiplied by the daily periodic rate, and the interest calculated is added to your balance each day.
This daily interest accumulation adds up fast and can significantly increase your balance. When your next statement arrives, it will contain your latest purchases added to the balance from your last statement, along with the interest you’ve accrued.
Getting to a $0 Balance
It’s pretty sobering to think about how long it can take to pay off credit card debt if you make only the minimum payment each month. Be aware that, as you are paying down your balance, the amount of your required minimum balance may go down. That might seem like a good thing, but it means you’ll end up taking even more time to get rid of your debt.
If you look at your statement, you’ll see that it contains that information because credit card companies are required to provide it. And payment calculators are available online to help you figure out how long it will take you to pay off a credit card bill.
Here are a couple examples:
- If you owe $10,000, have a 15 percent interest rate, and make just the minimum payments, it will take you almost 28 years to pay off your debt and cost you almost $21,000 in interest.
- If you owe $3,000, have a 15 percent interest rate, and make just the minimum payments, it will take you about 16 years to pay off your debt and cost you $3,641 in interest.
As you can see, paying off credit card debt can take a long time. The lesson, obviously, is to try to avoid making charges you can’t pay for.
Pocket Change
A company called Total Debt Relief has a video on YouTube that illustrates in a very entertaining manner how long it would take to pay off credit card debt. You can find it at youtube.com/watch?v=Vz05A6cP6Iw.
Credit Counseling, Debt Settlement, and Bankruptcy
Nobody wants to get into serious debt, but it happens all the time. We’re assuming you won’t need any of the options explained here, but it won’t hurt to have an idea about how credit counseling, debt settlement, and bankruptcy work.
Credit Counseling
Credit counseling has been available for more than a half century to advise, serve as an intermediary with creditors, lower interest rates, and consolidate monthly bills. Many reputable, nonprofit companies provide these services, but be aware that numerous scam companies have surfaced over the past decade or so. If you get involved with one of the latter, you could end up with even bigger problems than you started with.
If you’re thinking of seeing a credit counselor or counseling firm, it’s important that you keep a few things in mind. For example, ask what the total monthly fee will be. You should never have to pay more than $50 a month for the services of a credit counselor. Some predatory firms charge as much as 10 percent of their customer’s payments, which ends up totaling a couple hundred dollars a month.
Check with your local Better Business Bureau or Consumer Protection Agency to see if any complaints have been filed or any current investigations are underway about the firms you’re considering.
Never sign a contract at the first meeting. Be certain you have time to understand the agreement, the repayment schedule, and the fees. Never disclose your bank account number before you have signed a contract.
Be wary if a counseling service doesn’t suggest other options besides its own debt management plan. Remember, it might be possible to sell some personal property or refinance your mortgage to lower your debt rather than embarking on a debt management plan.
Lack of affiliation with the National Foundation for Credit Counseling or the Association of Independent Consumer Credit Counseling Agencies may be a reason to avoid a firm. Such an affiliation doesn’t guarantee you’re getting the best firm, but it does mean the company obtains a majority of its income from grants and donations rather than from fees alone.
And remember, if it sounds too good to be true, it probably is.
Money Pit
Credit card companies have minimum-payment guidelines they use to lower their interest rates, so there’s minimal negotiation for most folks. Beware of the firm that promises to remove your unsecured debt, offers to pay off debts with pennies on the dollar, or guarantees you’ll avoid bankruptcy.
Debt Settlement
Debt settlement companies charge clients a fee to settle debt with a credit card company or other debt collectors. Typically, a debt settlement firm gets a credit card company to agree on a reduced balance that’s considered payment in full and then charges the client for its services. Debt settlement also is known as debt arbitration or debt negotiation.
Although credit counselors typically get creditors to agree they won’t continue to try to collect from a client when the client is in the credit counseling debt management program, debt settlement companies often don’t provide that service. That can result in creditors charging late fees and penalty interest charges as well as continuing to pursue collection.
Seeking the services of a debt settlement company should definitely be a last resort.
Pocket Change
Some credit card companies have standard policies for how much debt they’ll forgive. If that’s the case, you’ll do as well negotiating with the company on your own as you would using a debt settlement company.
Bankruptcy
If you absolutely don’t have enough money to pay what you owe, bankruptcy is a possible option. Achieving bankruptcy can give you a fresh financial start by erasing your debt. However, it definitely is not for everyone.
Basically, there are two types of bankruptcy:
To qualify for chapter 7 bankruptcy, your income has to be below a certain level. For chapter 13 bankruptcy, your debt must be below a specified amount.
Even if you qualify for bankruptcy, however, certain types of debt called priority obligations won’t be eliminated. And filing for bankruptcy can have long-lasting financial consequences.
Definition
Priority obligations are certain types of debt you’ll still be responsible for when you file for bankruptcy. These can include child or spousal support and certain income taxes.
If you are ever at the point that you’re thinking about filing bankruptcy, consult a bankruptcy attorney who can help you decide if it’s the right move.
Credit Card Safety
For those who weren’t already sensitive to the pressing need to protect credit card information, the Target data breach of 2014 probably came as a big wakeup call—40 million credit and debit card numbers were stolen from Target during the holiday shopping period, giving new meaning to shoplifting and rocking the card industry.
News of other major breaches followed, forcing both the industry and consumers to start asking how to keep their information safe. Although credit and debit card fraud and theft are common, you can take steps to ensure your cards are safe.
Safety Tips
Most trouble occurs with credit cards that have been lost or stolen, so you need to keep close tabs on your cards. This is especially important when you’re traveling or in an area where pickpockets are common. Pickpockets in some cities, including Barcelona, Rome, Prague, Paris, Hanoi, and Buenos Aires, are notorious for their skill and frequency. It takes only seconds on a crowded street or train for a thief to grab your wallet and start racking up debt on all your credit cards.
Dollars and Sense
If you report a lost or stolen credit card before someone else uses it, your issuer can block the card and account number so they can’t be used and also issue you a new card and number. If the card has already been used by the time you report it, U.S. law stipulates that you can’t be charged more than $50 for those fraudulent purchases. Many issuers waive that charge if you report the card promptly. If your debit card is lost or stolen, the amount you might be charged depends on how quickly you report the loss, so speed is urgent.
Remember that someone looking to use your card doesn’t need to have the actual piece of plastic to use it—only the account number and expiration date. Consider these tips to help avoid having someone steal your information:
- Don’t ever share account numbers or personal information by email, even if requested in an email that looks like it’s from your bank or other official institutions.
- Request for and pay your statements online to avoid having your information in the mail.
- Sign the back of your credit or debit card in ink as soon as you receive it, if applicable. Some new chip cards don’t require a signature.
- Keep your credit and debit cards in a place where no one can see them, and be careful to keep your personal identification number private when using your debit card.
- Don’t ever give your credit card number to someone over the phone unless you’ve initiated the transaction.
- Keep anything containing your card numbers in a safe place, and shred any papers before disposing of them.
- If you move, give your credit card company advance notice so your statements and other information don’t end up in someone else’s mailbox.
- Your credit card company will contact you if it suspects fraudulent charges to your card, so be sure it has your current contact information.
- Be sure you get your card back from the sales clerk after using it in a store.
- Hang on to receipts for credit and debit card purchases, and check your accounts frequently to ensure they match.
- When signing a receipt or check, draw a line through any extra spaces. For instance, if you’re paying a restaurant check with a card but leaving a cash tip, cross out the tip line on the bill.
Dollars and Sense
Some people are reluctant to sign because of security concerns, but credit card companies claim it’s the best and safest method of preventing someone else from using your card.
Most credit and debit card fraud is preventable, and you can avoid a lot of trouble by being diligent with your cards and using common sense. Credit and debit cards can quickly change from a convenience to a huge hassle if they’re lost or stolen, so be aware of where you keep them and how you use them.
Electronic Safety Tips
Our electronic devices make it possible for us to bank, shop, and stay in touch from anywhere, but they also can make us vulnerable to security breaches. It’s very important to safeguard your devices and networks as much as possible to avoid problems.
- See if your bank offers fraud protection software. Many banks offer this service for free.
- Download and install authorized software and operating system updates as they become available.
- Be sure your computer and internet have a firewall to prohibit unauthorized users.
- Install virus-protection software on your computer, and get updates as soon as they are available.
- Only make purchases from secure sites when shopping online. Look for web addresses that contain https.
- Secure electronic copies of receipts and confirmation numbers by printing or saving them to your desktop.
- Assign highly effective passwords to all accounts, and keep them secret. Change them periodically.
Pocket Change
If you don’t already have a credit card with an embedded microchip, chances are you soon will. A chip card looks like a standard credit card but contains both the traditional magnetic stripe and a new microchip. The chip provides enhanced security, and these cards will soon be standard, as liability for security breach is transferring onto merchants who do not employ chip card technology.
Credit card companies and retailers are working hard to improve security, but it continues to be a serious and well-publicized problem. You’ll do well to remain vigilant with your credit cards and check your accounts often.
The Least You Need to Know
- Credit cards are great when used responsibly, but they can lead to financial nightmares when they’re used to buy things you can’t afford.
- It makes sense to use a credit card in certain situations, but not in every situation. Debit cards often are a good alternative to cash or credit cards.
- If you pay only the minimum fee on your credit card bill, interest will accrue, and it could take you a very long time to pay off your debt.
- If you get into trouble with your credit card bill, help is available.
- Regardless of how many or what types of credit cards you have, be sure to safeguard them to the greatest degree.