High interest debt is great for your creditors, but not for you.
Once a month your credit card bill shows up. Depending on if you have this cost covered in your budget, sometimes it’s a surprise. Consumers have shifted over the years to using credit cards as cash; accounting for 26% of consumers preferred spending method. While you spend without immediate repercussions, the balance, interest and fees compound to create a high interest debt trap. This is especially true if you’re only able to make small, or minimum payments.
Credit card troubles often stem from a misunderstanding of the impact of high interest debt. When dealing with credit cards, a notoriously high interest rate type of debt, it’s very important to avoid falling into the high interest debt trap. A minimum payment generally covers between 1-3% of the total balance, plus interest, fees, or penalties. For many consumers, the minimum payment is what they factor into their budget. If that amount fits, then spend without care! What they don’t realize is making your minimum payment only is a life sentence of repayment. Not to mention, you’ll end up paying far more than you originally spent.
Let’s break it down: The high interest debt trap is meant to… trap you.
The average credit card interest rate in 2019 is 15.09%, the highest it’s been since 1994. What does this actually mean to you, the consumer, if making minimum payments?
You reach a combined credit card balance of $15,700, with a minimum payment of $314 (2% of balance). Assuming you stop using the card now, and continue making this payment, it will take 80 months to repay (that’s almost 7 years.) More concerning, you will pay an additional $9,198 in interest – This is the high interest debt trap. Feel free to recreate this scenario yourself, or try inputting your own debt to see how much your interest will affect you.
At this point it should be fairly obvious, but in order to avoid this trap you have to pay more than the minimum payment. Essentially, you have to beat the interest. Remember, all credit cards are interest free if you pay off the balance in full each month. This is truly the only way to use credit cards without facing exorbitant interest charges.
But the minimum payment is all that fits in my budget?
This is the case for many Americans; there simply isn’t enough money coming in to cover more than the minimum payment. Before we discuss how to finagle more room in your budget, we need to address the root cause. As consumers, we struggle to live within our means. When the cashflow runs dry, it seems like a quick and easy solution to open a line of credit. This is the result of basing your budget on a minimum amount.
The key is to avoid falling into this high interest debt trap in the first place. In order to maintain your credit, you should aim to keep your credit utilization around or below 30%. So, if you’re given a credit limit of $10k you should consider setting a spending limit of $3k on this card. Not only will this keep your credit utilization at a healthy level, it prevents you from charging any more to a high interest credit card. Following this formula will not only improve your credit, it will greatly help to maintain it.
I didn’t budget correctly, and now my cards are maxed out.
First things first, we’ve all been there. This is especially true around the holidays when spending is at an all time high. Once you’ve crossed the threshold and maxed out your cards, it becomes far more difficult to dig yourself out. You have a couple options, though. There’s several ways to tackle your high interest debt, even if you have no options to increase your income.
Of course, this should be your first consideration, is there anything you can do to increase your income? Side job, sell some old stuff, ask for a raise – all possible methods of increasing your incoming money. We won’t dive too deep into this subject as there are a plethora of excellent articles discussing this already, like this one for example.
But for many of us, adding income isn’t an option. Your next option is to choose one of the many methods for reducing your debt yourself. Some of these methods include debt snowball, debt avalanche, balance transfers, debt stacking, or personal loans. We could dedicate an entire article to each of these methods, and their various advantages/disadvantages, in the meantime here’s a good one that briefly sums them all up.
Overwhelmed? You’re not alone.
We always encourage consumers to attempt to reduce their debt themselves. But, it’s a tough road, and we understand that. All of the above mentioned methods require high-level organization, and strict adherence to a budget. If these are within your skillset, then you have all the tools needed to tackle your own debt.
However, if you’re like 80% of Americans, you’ll need help. Minimum payments are designed specifically to keep you in debt, and generate profit for the creditor. The longer you make these payments, the more difficult it becomes to resolve your debt completely.
What if I consolidate all my debt into a lower interest card or loan?
Debt consolidation is best suited for individuals in light debt. Ultimately, consolidating is trading debt for debt, with a slightly lower interest rate. What you can do with consolidation is make paying your debt easier. For many people in non-emergency debt situations, consolidation can be a good option, especially if you’re not struggling to make your monthly payments.
For example, let’s take the original example balance of $12,500 with a 15.09% interest rate. You successfully consolidate this and a couple more debts to get a single monthly payment. Once your other additional debts are added, in total you’re consolidating $15,700 in debt. The consolidated interest rate is a lower, more manageable 10.9%. This will result in a lower monthly payment for you, and this payment covers all your debt, rather than sending individual payments to various creditors.
Now, let’s complete the same calculation as before to see how much time and money we’ve saved consolidating our debt. With $15,700 in debt, making a minimum payment of 2% ($314) on your single consolidation loan, your debt will be paid off in 5.5 years, and you will have paid an extra $5,324 in interest.
So, clearly consolidating your debt will save you some money. Your debt will be paid off in 5.5 years instead of 9, and you’ll pay $5,324 instead of $9,198 in interest. Not bad, especially if this debt is not delinquent, or causing financial stress of any kind. But, it should be noted, this method is still high interest debt, and you’ll still pay over $5,000 in interest.
How to get out of the high interest debt trap.
Without examining the previously mentioned methods in detail, you simply need to pay more than your minimum payment, consistently, every month. The best scenario is that you pay your balance in full every month, effectively avoiding interest of any kind. The methods help you to determine “how” you’re going to accomplish that. You may choose to tackle the highest interest debt first, sending additional payments to the principle to reduce the overall effect that account has on your budget and credit.
Alternatively, you may choose to work on your smaller accounts first, regardless of the interest. This method can help consumers feel like they’re accomplishing more because accounts are being closed, albeit small accounts. It’s important to remember that your highest interest debt is going to have the most long-term impact on your finances, and ability to repay. Our advice is usually to tackle your highest interest debt first, but this is a choice for you to make, based on your personal situation.
As a company, we’ve been helping people out of this type of debt for close to 15 years. Our method is settlement, and we take great pride in our companies reputation, and accomplishments. If you’re stuck in a high interest debt trap, sometimes you need someone to pull you out. Our program offers consumers the fastest, most inexpensive method of getting out of debt. Qualifying is simple and our certified agents are standing by to discuss your situation, and see how we can help.
Your partner in debt relief,
Consumer First Financial