How to Avoid Credit Card Debt

by A.D Paterson on 06/10/2010

How to avoid debt, and in particular credit card debt, has become a major issue in most people’s lives. We’ve discovered, in recent years, that we aren’t always going to have someone there to bail us out if it all goes wrong; so what do we do?

In this article we’re going to look at how to avoid debt from credit cards. We’ll start with why people seem to run up a large credit card debt, then we’ll have a look at how much this seemingly free money is costing us, and, finally, we are going to look at some ways of crunching the credit card debt.

Why are people constantly adding to their credit card debt?

Isn’t it a real hassle to carry money around with you? You go out to buy something and then find that, for just a few dollars more; you can get something else that you think you might really need in the future. If you’ve only got enough money for the thing that you originally went out to buy – what are you going to do?

Did any of that sound familiar? If it did you’re not alone, and the credit card companies know it.

We are living in an age where instant gratification is actually possible, and actually expected by most people. There used to be a time when you had to save to get the thing you wanted, and save even more if you discovered something else that would go really well with it. But all of that has changed over the last couple of decades.

People now use credit cards for the majority of their transactions, and are constantly surprised when the amount owing on the credit card mounts up. Part of this is down to the ease of use of a credit card and part of it is down to the fact that we don’t really equate the money being added to a credit card with actual money being paid to someone. Would you spend quite so freely if you were physically handing over cash as opposed to handing over a bit of plastic?

How much is this debt actually costing us?

Most people don’t realise that the amount owing to the credit card company is going down by very little each month. The card companies take the majority of your monthly payment and pay off the interest you owe first. That means that if you just pay them back the minimum amount of money on the statement then, several months down the line, you will have paid off very little of the actual money you put on the card in the first place.

As a quick illustration of just paying the minimum per month we’ll go for a modest outstanding credit card debt of $2000, an APR of 17.9%, and a minimum repayment of 2% or $5 if it’s the smaller of the two. Based on those figures your $2000 debt would take 35 years and 2 months to pay off, and the interest alone would cost you $4,091, just a touch over twice the amount of the original debt on the card.

Of course, all of that assumes that you don’t continue to use the card when you’re shopping.

If you have an offer to transfer a balance to that account you will, in the case of most card companies, be paying off any debt already on the card first. That means that the incredibly low rate you got when transferring may not make any difference to you, not if you haven’t started to pay it back before the lower rate finishes and you’re paying back at the full rate.

Do you know how much interest you’re actually paying back to the credit card company? There can be a huge difference in the amount of money you may be paying back to one card company in comparison to another card company.

So, how do we avoid debt from credit cards?

The simplest way would be to cut them up, but most people won’t go that far, so let’s look at some alternative solutions.

The first is to only put money on the credit card that you’ll be able to pay back by the end of the month. If you can pay the money back before the interest is due to be added (because the interest isn’t instantly added when you make a purchase) then you will have been able to buy the things you needed without them costing you any extra.

The next thing would be to look at using money you have ‘saved’ so as to clear your cards. Let’s say (to simplify the maths) that you are earning a whopping 10% on your savings of $1000, but, you have $1000 outstanding on a credit card at 20%. Over the course of a year you would earn, from your savings, $100, you would pay the credit card company $200 in interest, meaning you actually lost $100 over the year. If you take the money from the savings, and pay off the card, you have suddenly saved yourself $100 – even more if you weren’t going to be able to pay it back within a year.

Consolidation loans always sound like a good idea, but are they? You will be paying a lower interest rate, but you may be locked in for a certain length of time. To get out of some of these loans can often mean paying the equivalent of two to three months worth of interest. If you’re thinking about taking out a loan, and expect to pay it back quicker, try calculating what would happen to the credit card debit if you paid it on that instead.

Always check out your options thoroughly.

So, what have we learnt about how to avoid credit card debt? First, having no credit cards is a good place to start, but not always practical. If you must spend money on them then try to only spend money that you can repay within a month. If you have to over spend, then using as much of your savings as it takes is by far the best repayment option. Never pay back just the minimum, and always know your interest rates.

If you follow this advice you should find it a lot easier to avoid credit card debt.

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{ 7 comments… read them below or add one }

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