Financial Literacy: Debt
Escaping the credit card trap
November is Financial Literacy Month in Canada. And this year’s theme is “Take charge of your finances!” That little slogan was never more true than when dealing with personal debt, especially credit card debt. According to the credit rating agency TransUnion, the average credit balance in July 2019 stood at $4,236. And about 50% of those with credit cards do not pay the monthly balance off each month. With interest rates on credit cards getting as high as 30%, carrying even a small monthly balance can get costly over time. Carrying a large credit card balance can be financially devastating.
Some people can manage their credit cards, but many find themselves in difficulty at the end of each month. You may be in this leaky boat if you have a handful of cards and are unable to pay them off in full each month. You’re in trouble if you can’t make the minimum payments on some or all of them. And you’re in crisis if you’re getting past-due letters, phone calls, or personal visits by debt collection agencies.
If you’re in this sort of predicament and find you’re living paycheque to paycheque, try to pin down what you’ve been using your credit cards for. Several large one-time purchases, like appliances or home renovations, can add to the debt load very quickly. And this is manageable through a disciplined saving program, or a balance transfer to a personal line of credit or short-term personal loan where the interest rate is much, much lower.
On the other hand, if you use your credit card like a bank machine, largely on impulse purchases (everything from your coffee run to lottery tickets), you’re engaging in bad borrowing behaviour and you need to make some drastic changes, starting with some serious spending controls.
How to control spending
Start with a budget. Determine how much you spend each month and subtract it from your take-home pay. If you’re spending more than you make every month, you’ve identified your problem. Now you have to create a budget that itemizes what you’re spending your money on. Cover the essentials first, like rent or mortgage, food, car payments, and utilities. What’s left over, mostly those “little” impulse buys, are what’s adding up to your credit card debt.
If you have multiple cards, remove those with the highest annual interest rates place them in an inconvenient, difficult-to-access place. Leave only one card with the lowest, most favourable rate available for emergency use. In other words, when you find yourself in a hole, stop digging! Make a rule that if you can’t pay cash (or use a debit card), don’t buy it!
How to pay credit card balances
Paying off large credit card balances might seem like an insurmountable task. But after you’ve put the brakes on your bad borrowing habits, and freed up some extra funds for the month, there are a few tactics you can use to start chipping away at the debt mountain.
1. Minimum payments. Pay at least the minimum monthly payment on every card. Add more to at least one card with the highest interest rate.
2. Balance transfers. A zero-interest balance transfer to a different credit card under a time-limited promotion could give you breathing room of as much as six months with no interest. Any monthly payments you make to the new card would go directly against your principal amount. Be sure to check terms and conditions after the interest-free period expires. Do not use the old card again. And remember that if you go this route, you are in fact applying for a new credit card and it goes on your credit record.
3. Rate switch. You may be eligible for a premium card. You’ll pay an annual fee, but the interest rate charged on these cards can be less than half that charged on no-fee cards. What you spend on the annual fee (anywhere from $99 to $150 per year) will be offset by savings on compounded interest payments. Get more information from your credit card company, often your bank, which is always pushing premium cards anyway. Again, if you go this route, be sure your old card is cancelled.
4. Line of credit. Consider paying down some of your credit card balance using your line of credit, where interest rates are considerably lower. But use personal lines of credit sparingly, and make sure you pay off at least the scheduled minimum amount, preferably more, each month.
5. Personal loan. This involves taking out a personal loan at a lower interest rate to pay off higher-interest credit-card loans. Your bank’s loan officer can work out a payment schedule to fit your budget. Remember to lock away all credit cards (with the possible exception of one low-interest card) until that personal loan is paid off.
6. Getting help. Finally, be skeptical of so-called “credit counselling services,” especially of the strip-mall, store-front variety. You may end up in an even worse debt crunch than before. If you’re concerned about credit card debt problems, talk first to your bank or consult with a fee-for-service financial planner or advisor.
Although it’s tempting if you’re in a real bind, avoid declaring personal bankruptcy. Bankruptcy is a legal morass and will impede your ability to borrow and conduct your other personal financial and business affairs, including investing, for years to come. So make every effort to fix your credit card crunch using the tactics I’ve outlined here. It takes persistence and fiscal discipline, but it can be done.
Robyn Thompson, CFP, CIM, FCSI, is the founder of Castlemark Wealth Management, a boutique financial advisory firm specializing in wealth management for high net worth individuals and families. Contact her directly by phone at 416-828-7159, or by email at email@example.com for a confidential planning consultation.
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The foregoing is for general information purposes only and is the opinion of the writer. Securities mentioned are illustrative only and carry risk of loss. No guarantee of investment performance is made or implied. It is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice. Please contact the author to discuss your particular circumstances.