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How to minimize holiday debt

Debt. You spit the word right out of your mouth when you say it.

That's the reaction many of us have after seeing what we've done to our credit card and bank balances each month.

That response is a good thing for most people -- if you're naturally debt-averse, you're unlikely to end up in bankruptcy proceedings because you forgot to pay the Visa bill. It's good to learn early -- and cheaply -- that debt isn't always your friend. Learning to manage what you owe can be the most rewarding thing you do with your money.

During the holiday season, people tend to rack up even more debt than usual. According to the National Retail Federation's 2004 holiday shopping study, the average American will spend 4.5 percent more this year than they did last year. We'll spend $541 on gifts and $161 on food, flowers, cards and decorations. Come January, the credit card balances will only compound the post-New Year blahs.

Even though blowing a lot of dough on presents is inevitable for most people, there are a few ways to keep your spending on track.

Get in touch with your inner Scrooge
Holidays can be difficult for even the best money managers. People invariably go over budget as forgotten or last minute gifts are needed in a hurry. Plus people more often buy with their hearts than with their heads.

Guilt can also be a marvelous economic motivator -- it's easy to think we can make up for a year's worth of arguments or missed appointments by pushing the gift exchange just five more dollars. Five bucks may not sound like much, but money has a great ally and a great enemy in Father Time.

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Think about the following scenario the next time you're about to drop a few extra dollars on a present.

One family socks away $5 per month, every month, for 30 years. The other routinely spends all that they earn, plus another $5, every month for 30 years.

At the end of the first year, family No. 1 has just over $61 ($5 times 12 months plus, by putting their savings into an interest-bearing account offering 5 percent, they add a little more than a dollar to their total savings).

Paying an annual percentage rate (APR) of 18 percent, family No. 2 already owes more than $65 -- and they likely owe even more since credit cards use the least advantageous method of "average daily balance" to determine the amount to which they will charge their interest.

After 10 years, the first family has stashed away about $775. Meanwhile, the second family is now nursing a debt load of more than twice that (roughly $1,650) just by adding a mere five dollars per month to their debt.

Shoot these projections out 30 years and the results are dramatic. The first family will have saved more than $4,000 while the other family now owes over $70,000. It's pretty amazing what a difference just $5 saved or spent can make over time.

Someone was once asked by a surprised friend, "How did you go bankrupt?" The answer: "Slowly at first, and then all of a sudden."

This year, after making out your holiday shopping list, make a budget and stick to it.

Be credit card savvy
Credit card advertising is very seductive. With card A, you'll always have enough money. Use card B and people will respect you. Actually earn money or frequent flier miles on every purchase with Card C.

Credit cards allow you to charge your way into wealth, respect and prosperity. Now that's priceless.

Plastic can make buying a gift you can't afford seem easier. The money may not be in your bank account now, but you just got an increase on your available balance and it IS the holidays and you promise to pay it off in January and gifts are good, right? And ... the excuses go on.

Beware of such banter with yourself.

The best laid plans can still go awry. The Consolidated Credit Counseling Services, a nonprofit organization that helps people solve money management and debt problems, found in their 2004 holiday survey that 39 percent of the consumers were still paying off the previous years holiday spending debt.

The first, and easiest, step to using credit cards wisely is not to charge more than you can afford to pay that month. Failing that, make sure that you pay more than the minimum. We've seen the power of five little dollars -- sending in just $5 or $10 more per month can reduce the time and total amount of interest you pay significantly.

Lastly, be on time with your payments every time. Paying on time can help you qualify for the best interest rate available. Find out what rate you're paying now and if you think you can do better, ask your credit card issuer to lower your APR. There's a pretty good chance they'll agree. They'd rather do that than lose you -- and all your interest-paying dollars.

If they call your bluff, the Internet has made shopping for alternatives easier than ever. Try Bankrate's credit card search engine to find the card that fits your needs.

Debt -- it's not always so bad
Debt is not necessarily a bad thing. It's a tool.

Debt makes it easier for us to buy a home, a car or a DVD player. It allows us to smooth out irregular purchases by paying a set amount each month and we don't have to carry around an inconvenient wad of cash.

Debt can, in fact, be a marvelous force for good in our financial lives -- if respected and used wisely.

You owe it to yourself, pardon the pun, to shop around for the best interest rates and annual fees on your credit cards, car loans and other obligations, and to spend within your limits, especially during the holidays. That way, the only thing you'll have to worry about reducing this January is your waistline.

-- Updated: Oct. 25, 2004


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See Also
18 ways to save money during the holidays
Secrets of a smart shopper
Quiz: What's your holiday gift-buying style?
Investing glossary
More investing stories

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