Escaping the debt hole
By Mindy Fetterman
USA Today
You've heard the staggering numbers: Consumers had $2.1 trillion — with a T — in outstanding debt at the end of 2004. That's up 5 percent from the year before, up 9 percent from the year before that. As a nation, our consumer debt has doubled in the past 10 years.
As an individual or household, your debt might have done the same.
And it's killing you. You can't save as much as you want, or should. You can't buy a new house, or save for college.
Much of the country's debt is on credit cards. How do you get a handle on that? Jean Chatzky, author of "Pay It Down! From Debt to Wealth on $10 a Day," answers some questions about credit cards.
Question: What are the worst mistakes consumers make with their credit cards?
Answer: We got in this position by making a series of smaller mistakes. Most people have been living on more than they make. We told ourselves that was OK, because we were making so much in the stock market or on our houses.
People bought into the logic of the credit-card companies. When they send you card after card, it's easy to convince yourself that if they think you can handle it, you think you can handle it. But they've just run the numbers of how many defaults they're willing to risk. And they're willing to risk on you.
Q: How do you know when you're really in trouble with your credit cards?
A: When you start rolling one card over to the next card, using one card to pay another.
Q: How do we get out of debt?
A: First, assess the problem. Get all your credit-card statements out and write down how much you owe at what interest rate and who you owe it to. What are the minimum payments and the total payout? Include credit cards, car loans and student loans, which you may be able to refinance.
Pull your credit report with the score. You need to get that score up for the next six months before you try to refinance anything, or you'll pay too much interest.
Q: When should you worry about your credit score?
A: If it's below 660, it needs work. Go to myFico.com. It has instructions on what to do. You may have too many credit cards, and you need to close them. Maybe you've been paying late. Maybe you're close to being maxed out.
But in just six months of paying on time, you can pop your score up. A year is better. If you have a decent score, refinance your house, your car loan, your student debt.
Q: What should we do first about the credit-card debt?
A: Call your credit-card companies and ask if they'll give you a break on the interest rate. If you're at 18 percent and you've been a great customer and you've been paying on time, you have some leverage. Tell them you just got an offer for a 0 percent card on balance transfers. You don't want to switch, but you have to. They'll probably lower your rate.
You don't have a lot of pull with credit-card companies if you've been a late payer.
Q: Which card should you start paying down first, the one with the highest interest rate?
A: No. When you go to pay down debt, focus on the one that's close to maxed out and pay minimums on the others. Pay about 60 percent of the balance on that one. Then just pay more on the card with the highest interest rate first, and minimums on the others. That's the card that's costing you the most money. Stick it in a drawer.
Q: What about closing an account?
A: Closing an account will actually hurt your credit score. Part of the score is based on your "utilization ratio" — or the percent of credit you're using. If you cancel an account, you lower the amount of credit available.
It's not good to have too much credit you're not using, either. The card companies view you as someone who could go on a bender at any time. But if you don't have enough credit, it means other (companies) don't view you as a responsible party.
Q: Should you take out a home equity loan to pay off your credit-card debt?
A: It's an OK strategy if you are one of those people who knows yourself extremely well.
I've seen research that shows about one-third of the people who use home equity loans to consolidate debt rack up more credit-card debt within a few years. Then they have a home equity loan and credit-card debt. They've dug themselves deeper in the hole.
From a numbers perspective, it makes perfect sense. Interest rates on home equity loans are lower, and it's largely tax deductible. But you can get in trouble if you're not careful.
Q. What's the best way to wean yourself off credit cards?
A: If you can get yourself trained to use a debit card instead, do it. That way, the money is coming right out of your checking account, and you can't spend more than you have. Do a test drive and see if you can do this.
