Credit Card debt and how to deal with it

Credit Cards – an unfortunate fact of life, Credit Cards are here to stay. Using them well however is not easy and the potential for misuse is extremely high. If you have gotten into the unfortunate situation of having “maxed out” your credit card(s) you are going to have to sort this situation out extremely fast.

I hope I don’t need to tell you about the ruinous interest rates charged by credit card companies and the fact that just paying your minimum balance is a recipe for disaster! In case you aren’t aware of how bad this really is though, see my notes on it below.

If you are in the even worse situation where you’re unable to pay your minimum balance then you have other ... larger ... issues that you should really look into eliminating and you are going to have to consider some more drastic solutions – up to and including bankruptcy protection or the equivalent as despite the impact it will have on your credit rating, getting rid of the debt will allow you to live your life to some extent.

In its simplest form, interest rates are basically what it “costs” us to borrow the money. For example if your interest rate is 16%/annum then on every £100 of debt that you have outstanding you would be required to pay £16 interest/year. In a weird twist, the interest that banks pay us on the money we have on deposit with them is generally significantly lower - 3-4% if you are lucky and it is this "spread" that banks use to make their money.

If you think about it like this it actually sounds like a lot and the question to ask is why would anyone pay that? If you consider that “store cards” have interest rates closer to the 30% mark it sounds even more ridiculous. However the way that “they trick” us (and note, when I say “they” its really only us isn’t it?) is by showing us the calculations based on a monthly basis. Now £100 of debt outstanding still equals £16 in interest, but if you divide it by 12 ... its only £1.33/month ... wow, that doesn’t sound as horrible, does it?!

So what does all this mean? Well, first make sure that any borrowing you do need to do is at the lowest possible interest rate that you can arrange. Make sure that you are aware of what the interest rates are for each of your debt products and if you can, sort them out based on this criteria as it makes sense to focus on those with the highest interest rate first. Always ensure that you are paying down the interest rate that your card provider has indicated (Note: do not confuse this with the minimum repayment!).

As discussed above, repaying credit cards gets confusing because the minimum repayment doesn't necessarily have any relation to the interest you are being charged! Unlike loans and mortgages which have a fixed end and as such the repayments directly tie towards your "clearing" the debt, with credit cards you have the "flexibility" of choosing what to pay (generally 3% of the outstanding amount with a certain fixed minimum). The more you pay, the faster you clear your debt and the less (or "suggested" minimum) and the longer it will take you to clear your debt.

• REMEMBER: the longer you borrow for, the more interest you have to pay and something else you might want to consider ...
• INTEREST ACCRUES so you could end up paying Interest charges on the Interest!!!

Now since this article and is devoted to getting out of debt, paying the minimum is obviously NOT something I would ever recommend ... while its great business for the Credit Card companies (as a personal aside, have you noticed that trying to get a higher credit allowance is really difficult if you pay off your balance in full, but its really easy if you carry a little bit of debt?) and obviously the way in which they earn their millions, its in our best interests to pay this debt down as quickly as possible.

Most people don't understand that minimum payments are first applied against the interest and only a small portion of that payment actually goes towards your outstanding debt. As your debt decreases, so does the minimum payment so you are not really ever getting ahead by just paying the minimum amount as most of your repayment usually goes just to paying that month's interest, rather than actually decreasing the amount you owe.

It'll take you 161 months (that's over 13 years) to pay back £1,000 if you only pay the required minimum of 3.00%. Over that period of time, you'll pay an additional £848.01 in interest.

If you could aford to pay an extra £10 a month towards your credit card debt, it would mean you'd repay it in 57 months (just over 4 years) and you'd save yourself £483.98 in interest. In fact, if you could aford an extra £25 a month, you'd repay it in 31 months (just over 2 years), and save £647.54

As you can clearly see, the fact that you're paying less money each month means that that the interest owed isn't just adding up, its compounding! Over the course of that 13 year period, you have actually paid almost as much in interest as the initial debt itself!!