Credit card users who find themselves in debt for large amounts of money need to take action to pay off the cards. Large balances have multiple negative impacts on consumers:
- Interest costs mount up quickly due to high interest rates.
- Consumers have difficulty saving for large purchases, such as a down payment on a home or vehicle.
- Large balances lower credit scores, which may result in higher rates on other loans.
- Balances owed count toward debt ratio calculations when financing a home.
The High Cost of Credit Card Interest
High interest rates are the primary reason for difficulty in paying off credit cards. A $20,000 balance on a credit card with a 12% interest rate means the credit card is charged $200 interest each month. A consumer might think this is $2,400 each year, except it really results in more.
The interest is added to the outstanding balance. If the balance is not paid off, interest is charged on the interest. This is called compound interest, which is very valuable for savings, but a heavy burden when the credit card user is paying.
Getting out of Credit Card Debt
The most important first step in eliminating credit card balances is getting control of monthly expenses. Consumers have to “live below their means,” which entails spending less than their monthly costs, either by increasing income or lowering expense.
Once this step has been achieved, people can address bringing down older balances. Consumers need to live below not only their current expenses, but it has to include current expenses AND interest cost on the amount of the unpaid balances.
Continuing the example from above, if the consumer continues to use that card, charging $500 each month, and paying only $500:
- After the first month the balance will rise to $20,200.
- At the end of the second, it will be $20,402
- After month three, $20,606.
- At the end of 12 months, instead of $22,400, the unpaid balance would be $22,536, $136 more than expected.
This calculation actually understates the balance in most cases. If charges are made all through the month and payments made just before the due date, interest will accrue on those new charges as well. Consumers will need to review their own credit card agreements to determine if this applies to their accounts.
Tips for Reducing Interest on Credit Cards
The best way to avoid credit card interest is to pay off the balance every month, if the card has a grace period. It that isn’t possible:
- Every dollar paid will reduce interest cost. The consumer should attempt to pay the new purchases and interest cost, and not just the minimum payment.
- Payments should be made as early in the month as possible, as this will reduce interest.
- New charges should be delayed as long as they can be, since these will incur interest from the date they are charged if there is a prior unpaid balance.
- If possible, maintain more than one credit card account, but always fully pay off at least one of them each month. New purchases should be charged on the one that is paid off each month. This will at least prevent interest on new purchases, until the other card can be paid off.
- Pay off the card with the highest interest rate, or use the card for new purchases that offers the best rewards, but make sure to pay it off each month.
- Consider using a balance transfer to consolidate credit card debt, but be aware of the high cost of transaction fees.
Eliminating credit card debt requires smart decisions and a consistent plan, but the benefits are financial flexibility and security.
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