charges on cards that have outstanding balances while you’re paying down your credit-card balance(s). Many people don’t realize that interest starts to accumulate immediately when they carry a balance. You have no grace period, the 20 or so days you normally have to pay your balance in full without incurring interest charges, if you carry a credit-card balance from month to month.
Apply for a lower-rate credit card. To qualify, you need a top-notch credit report and score (see Chapter 4), and not too much debt outstanding relative to your income. After you’re approved for a new, lower-interest-rate card, simply transfer your outstanding balance from your higher-rate card.
www.erictyson.com/, for an up-to-date list of good, low-rate cards.
Negotiating better rates from your current credit card
Rather than transferring your current credit-card balance onto a lower-interest-rate card (as mentioned in the preceding section), you can try to negotiate a better deal from your current credit-card company. Start by calling the bank that issued your current, high-interest-rate credit card and inform the bank that you want to cancel your card because you found a competitor that offers no annual fee and a lower interest rate. Your bank may choose to match the terms of the competitor rather than lose you as a customer. If it doesn’t, get that application completed for a lower-rate card.
Be careful with this strategy, and consider just paying off or transferring the balance without actually canceling the higher-interest-rate credit card. Canceling the card, especially if it’s one you’ve had for a number of years, may lower your credit score a bit, especially in the short term. Just be sure not to run up new charges on the card you’re transferring the balance from.
Tapping investments to reduce consumer debt
If you have savings and investment balances available to pay off consumer debt, like high-interest credit-card debt and auto loans, consider doing so. Pay off the loans with the highest interest rates first.
Although your savings and investments may be earning decent returns, the interest you’re paying on your consumer debts is likely higher. Paying off consumer loans on a credit card at, say, 12 percent is like finding an investment with a guaranteed return of 12 percent — tax-free. You’d actually need to find an investment that yielded even more — around 18 percent if you’re in a moderate tax bracket — to net 12 percent after paying taxes in order to justify not paying off your 12 percent loans.
The higher your tax bracket (explained in Chapter 6), the higher the return you need on your investments to justify keeping high-interest consumer debt. This discussion refers to investments in nonretirement accounts. Unless your tax bracket drops because of an extended layoff from work or from going back to school, withdrawing money from retirement accounts is costly because of the requirement to pay current federal and state income taxes on the amount withdrawn, not to mention early withdrawal penalties.
Paying down balances
If you’ve been reading this chapter from the beginning, you know that I discuss numerous strategies for zapping your consumer debt. Now I take the discussion to a deeper level. How do you handle paying down multiple consumer-debt balances? It’s really pretty simple after you implement the advice I give up until this point in the chapter.
After meeting the minimum required monthly payment terms for each loan, I strongly advocate that you channel extra payments toward paying down those loans with the highest interest rates first. The financial benefit of doing so should be obvious. If you have one loan at a 15 percent annual interest cost and another at an 8 percent annual interest cost, you’ll be saving yourself a 7 percent annual interest cost by paying down the higher-cost loan faster.
I’m amazed at the wrong-headed advice I continue to see on this topic, especially on the Internet. One guru with no discernible training in the financial-planning/personal-finance field advises that you rank your debt payments by their total outstanding balances and that you channel extra payments to those with the lowest total balance owed. The “theory” behind this is that the psychological boost from paying down smaller debts completely will lead you to keep paying down your other debts.
In my real-world experience as a financial counselor, I’ve found folks to be intelligent and more responsive to the psychological rewards of saving money. And you best save money by paying down your highest-interest debts first.
Getting Help for Extreme Debt
More drastic action may be required if you have significant debts or simply are overwhelmed with what to do about it. In this section, I discuss getting help from a credit counseling agency and the last-resort option of bankruptcy.
Seeking counseling
If you’re seriously in debt, you may consider a credit counselor. The ads for these agencies are everywhere. Although some of these organizations do a decent job, many are effectively funded by the fees that creditors pay them. Before you hire a credit counseling agency, make sure you do your research on the company.
Do you offer debt-management programs? In a debt-management program (DMP), a counseling agency puts you on a repayment plan with your creditors and gets paid a monthly fee for handling the payments. You should avoid agencies offering DMPs because of conflicts of interest. An agency can’t offer objective advice about all your options for dealing with debt, including bankruptcy, if it has a financial incentive to put you on a DMP.This creates a bias in their counsel to place debt-laden folks seeking their advice on their debt-management programs wherein the consumer agrees to pay a certain amount per month to the agency, which in turn parcels out the money to the various creditors. Agencies typically recommend that debtors go on a repayment plan that has the consumer pay, say, 3 percent of each outstanding loan balance to the agency, which in turn pays the money to creditors. Although credit counseling agencies’ promotional materials and counselors highlight the drawbacks to bankruptcy, counselors are reluctant to discuss the negative impact of signing up for a debt payment plan.
What are your fees, including setup and/or monthly fees? Get a specific price quote and contract in writing. Avoid any credit counseling service that charges a high upfront fee before it provides any services. And watch out if the service tells you to stop paying your bills; it may take your money and run while your credit
