Credit Card Debt: The Problem, Fixes and Prevention

    Credit Card Debt: The Problem, Fixes and Prevention

    By Alexandra Twin


    > Taking the Next Step

    With an economic recovery slowly kicking in, Americans are returning to one of their worst pre-recession vices – jacking up credit card debt.

    America’s outstanding credit card debt topped $935 billion last year, the highest level since 2008, according to the latest statistics from the Federal Reserve. On a practical level, the average indebted household owes more than $8,000, the highest amount since the start of the Great Recession, according to a recent study from credit card search engine CardHub.

    Pre-recession levels of spending reflect the impact of a recovery and the higher cost of living, factors consumers can’t avoid, but also a return to bad habits, said Brent Neiser, CFP and senior director of strategic programs and alliances at the non-profit National Endowment for Financial Education (NEFE).

    “The economy is growing slowly, but people are making adjustments,” Neiser said. While many areas of the country are struggling, “recovery is happening within individual households with people spending again on items they shied away from for years.”

    Long-term retirement savings are up, a positive, but many hard-earned lessons from the recession are not being observed, Neiser said, including the need for an emergency fund and a reassessment of spending habits.

    Don’t buy a $1,000 pizza

    Cutting debt but not changing the practices that got you into debt is pointless. Look at what you’re buying and why. You may think you spent $40 when you charged a couple of pies from your local pizzeria, but if it takes you five years to pay off the debt, your pizza actually cost you $1,000.

    Go through your online card statements for the last year and see what you actually charged, said the NEFE’s Neiser. Charges for items you would never want to pay interest on should be flagged. “When people really understand what got them into debt in the first place, they are less likely to make the same kinds of purchases on credit in the future,” he said.

    The Fixes

    Make a list of what you owe monthly per card and the card’s annual percentage rate (APR). Have a specific goal in mind for cutting debt like “I want to pay $50 per month per card over the minimum” or “I want to cut total monthly payments by $200.”

    Pay the minimum on everything except the card with the highest balance, on which you pay more. Or pay more on the card you owe the least on, said NEFE’s Neiser. That way you’ve paid off a few cards entirely and feel like you’ve made progress. Once a particular card is paid off, keep the account open, but don’t use it and you’ll increase your credit capacity long-term.

    Meanwhile pay off and close out the accounts on the credit cards that are the most tempting: department store or electronic chain-specific cards, which often send out coupons or other promotions, as well as credit cards that give you airline miles or other incentives. Swapping out these niche cards for more traditional credit cards tied to major financial institutions or a consumer credit union may help you spend less.

    Be aware that closing out available lines of credit lowers your credit score a little in the short term, because it lowers your credit capacity – or the total amount you’ve been offered on credit. But longer term it will improve your relationship with money and credit cards, improve your spending habits and ultimately your credit capacity, said NEFE’s Neiser.

    The Fair Credit Reporting Act (FCRA) requires the three biggest credit-reporting agencies – Experian, TransUnion and Equifax – provide consumers with a free credit report annually. To get yours, visit the central website the three agencies set up: AnnualCreditReport.com.

    Avoid those supposed debt consolidation agencies; many are misleading or fraudulent. Instead, seek the help of non-profit credit counselors that can help you cut your debt and create a budget. Try the National Foundation for Credit Counseling (NFCC).

    Check out the Federal Trade Commission (FTC), the country’s consumer protection agency as well.

    Prevention

    Planning for bad times and unexpected expenses in the present is a key part of avoiding credit card debt problems in the future.

    Experts agree that everyone should have an emergency fund. That way if you get into trouble again, it’s better to cash out that fund than to add to your credit card debt.

    But it’s also important to recognize that you will get older and may have health issues down the road. Without preparation, these developments often lead people to turn to their credit cards and subsequently get burdened with overwhelming credit card debt again.

    If you are part of the full-time workforce, take advantage of your company’s retirement plan if it has one. If it doesn’t or you are a contract or freelance worker, you should set up your own. (More on retirement planning)

    In addition, you should take advantage of health insurance and disability insurance, either offered through your employer or independently. Sudden medical expenses are the leading cause of personal bankruptcy, according to a recent study. And the chances that you will be too ill or injured to work at some time in your working life are one in four.

    If you have a family or people who depend on you and your financial well-being, life insurance is also something to consider. Aside from the protection life insurance offers some types can offer a source of funds in the future, albeit with some negative consequences in certain circumstances. Deciding what kind of life insurance is appropriate for you depends upon your circumstances (Learn more here).

    Of course contributing to all these considerations – retirement and insurance – reduces your immediate available income. But making such moves now may help you handle future expenses that would otherwise push you into a credit card crunch.

    “The idea is to live a little below your means, not within your means,” Neiser said. “That way you have a margin of safety.”

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