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Few things cause more financial distress and anxiety than a large amount of high-interest credit card debt.
Millions of Americans of all income levels have large balances on credit cards that charge very high interest rates. According to data from the Federal Reserve, the average annual percentage rate on cards issued by commercial banks was 16.45% at the end of last year, and the rates charged by store credit cards can exceed well over 20%.
While card balances have fallen significantly from a high of $927 billion at the end of 2019, they remain high at $841 billion at the end of the first quarter and could continue to grow.
“Credit card debt is still a big problem,” said Rachel Gittleman, financial services outreach manager at the Consumer Federation of America. “There were a few refunds at the start of the pandemic, but I think the sales could start to increase again as the cost of living rises.”
If you’re struggling to make minimum payments on credit card balances, there are options to help you reduce the amount you owe and/or minimize the amount of interest you pay on the debt.
However, there is no quick fix for high debt. The solution begins with changing your own behavior.
“The only long-term solution is to correct your spending habits,” said Summer Red, financial counselor and senior education officer at the Association for Financial Counseling and Planning Education. “Nothing will succeed if you don’t stick to a reduced spending plan.
“You need to get your expenses below your income level.”
A credit card balance of $10,000 with an interest rate of 20% costs you $167 per month and that only guarantees that your balance won’t increase. To start paying off the debt balance, you will need to do more.
There are two key aspects to controlling your spending; not using your credit cards and writing a sustainable budget that includes paying off card balances.
On the first front, Red suggests people cut up all but one of their credit cards. Don’t cancel accounts because your credit score will suffer
If you’re still having trouble using your card, put it in the freezer. “It takes about three hours for a credit card to thaw out and be ready to use,” Red said. “It gives you time to think about your purchases.” Use the card only for purchases that you are able to repay at the end of the month.
On the second front, you will have to make sacrifices to start reducing debt balances. This could mean downsizing a house or apartment, selling a car, or cooking more at home. It’s essential that you write a budget detailing all of your expenses and income to determine where you can cut spending and pay off debt.
Gittleman recommends getting help. “Every consumer’s financial situation is different,” she said. “They have different debts, different spending habits and different things of value to them.
“Working with a Certified Financial Advisor can help you determine your best options.”
When it comes to debt repayment strategies, there are two basic repayment models. The first – called the snowball method – pays off smaller debt balances first to give consumers some momentum. The idea is to pay the minimum amounts on all debt balances to avoid late fees or higher interest charges, then apply the remainder to your smaller debt balance.
When you pay off that balance, you move on to the next smaller balance. “The motivation to pay off a debt is very valuable,” Red said. “Being able to see this can be a powerful incentive for people.”
If you don’t need the positive reinforcement, you can focus on the debt with the highest interest rate first. In the long run, the so-called avalanche method – from the highest rate to the lowest – will save you the most on interest charges.
While changing your spending habits is the only thing that will permanently get you out of the debt hole, there are other steps you can take to reduce the amount you owe or lower the interest you’re charged. Here are four actions to consider:
- Call your credit card company to see if you can reduce the amount you owe or lower the interest rate on the debt. Do not lead with the possibility of declaring personal bankruptcy, but explain that you are unable to pay your current balance under existing conditions. Credit card companies want to get paid and they can offer some relief to make sure they do.
- Credit card balance transfers to other cards that offer no interest for a period may make sense, but they are not free. They may offer 0% interest for six or 12 months, but they usually charge 3% to 4% of the balance up front. If you don’t pay off the debt during this grace period, you won’t be much better off in the end.
- Consolidating your high-interest credit card debt and paying it off with a lower-rate personal loan can significantly lower your interest costs. Most likely it should be a home equity loan if your credit profile is poor. The downside is that if you don’t control your spending, your home could be at risk later.
- If your debts are just too much — very often because of medical bills, which are a key factor in 60% of personal bankruptcies — bankruptcy may be your best option. If most of your debts are unsecured, such as credit card balances and medical bills, bankruptcy can give you a fresh start. Speak to a financial advisor and a bankruptcy attorney before taking this step.