Financial Literacy 2007 - Credit cards
credit cards
Drowning in plastic debt?

The Plan

Curtail credit card spending. Stop using credit cards! Put them in a cup of water and freeze them. Better yet, cut them into tiny pieces. Leave the accounts open, but eliminate the temptation the cards present. It isn't wise to close out the accounts while still carrying a balance as this might trigger a punitive interest rate from the issuer. Also, should the debt-to-available credit ratio rise suddenly, this could lead to punitive interest rates on other cards or could prevent a balance transfer at an attractive interest rate later on.

Wendy
Wendy Reck

The challenge: Overwhelmed with credit card debt. Living paycheck- to-paycheck.

The plan: Reduce debt by selling assets and trimming expenses.

Follow-up: Chipping away at debt and feeling more in control.

Use cash or debit cards instead of charging. Even check writing has gotten Wendy into trouble by triggering an overdraft loan at 14 percent interest that will take another two years to pay off.

Credit card debt isn't her only problem. Overspending coupled with a lack of savings perpetuates the debt cycle. That's why I am not going to recommend using a home equity loan to consolidate this debt. Until she demonstrates a commitment to live within her means and dedicate herself to debt repayment, such a move is likely to backfire.

To that end, it is important to do the following.

Create a budget. Begin tracking every expenditure. Money is disappearing via ATM withdrawals and the debt load is a direct result of overspending. Wendy has done a good job of recording much of what she spends but it must be taken to the next step -- reconciling that against a monthly budget and the money coming in. She needs to focus on living within her means and throwing as much money as possible against her debt.

Speaking of debt, paying down the credit cards is Wendy's new mission. Any time Wendy feels the temptation to spend money she doesn't have, she should look herself in the mirror and ask out loud, "How committed am I?"

Be debt-free in 18 months

Immediately stop the I-bond purchases through payroll deduction. Instead, make regular contributions into a liquid, high-yield savings account.

Wendy can eliminate the $17,000 of unsecured debt in 18 months if she commits to sacrificing enough to do it. Here's how.

Sell the individual stocks held in the taxable account and use the proceeds to pay off the Sam's Club credit card. She has a lot of credit card debt costing in excess of 20 percent annually and the balances are going nowhere. Selling the securities will trigger a small capital gains tax bill that will need to be paid this time next year, so boosting the savings cushion will also be a necessity.

Wendy can truly accelerate the debt repayment by terminating the modest life insurance policy on her husband. This policy has a surrender charge that will remain in effect for another 11 years. The current cash value, net of the surrender charge, is $4,600.

Here are a couple considerations before taking this step. If she still wants an insurance policy on her husband, she can see if the accumulated cash value is enough to pay the premiums. This way she wouldn't have to pay out-of-pocket and could use the payroll deduction of $900 per year to reduce debt. She may, instead, opt to replace this coverage with a lower cost term policy. Or, because she is the primary breadwinner and they have no dependents, she may decide to skip such a policy altogether. -- My thanks to Ed Graves, associate professor of insurance at The American College, for his help in clarifying the workings of cash value life insurance.

Keys to success
  • Create a process for tracking every dollar spent and made.
  • Consistently spend less than you make.
  • Don't use credit cards to bridge the gap between income and spending.
  • Paying more than the minimum is vital to cutting interest charges and ultimately getting out of debt.
  • Have money directly deposited each pay period into a high-yield savings or money market account.
  • Create an adequate cushion: at least three months worth of expenses or a sum equal to six months of expenses for households with one primary wage earner.
  • Live within your means and devote at least 10 percent of your income to investing for the future rather than paying for the past.

If she terminates the policy, she could use the net cash value proceeds of $4,600 to pay off the Target card, the overdraft loan and put the remaining $500 into her savings account. Remember that $900 per year in premiums for that insurance policy? This, too, can be used to boost that much-needed emergency savings account.

At this point, she will have paid off more than $5,500 in debt, boosted her savings account balance and will have $412 per month to cover the minimum on the Chase card with the remainder being used to pay down the Union Plus card.

But now the real work begins. To keep progressing on the pathway to being debt free, Wendy must raise additional cash by cutting expenses, selling unneeded possessions or working overtime. All of this extra money raised can be used to attack the debt on the two remaining credit cards.

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Where does she begin?

Discontinue cash gifts to help out family members and consider ditching some of the extras, such as satellite TV. While it may not seem like a luxury because they live in a rural area, it costs nearly $900 annually.

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Balance Transfer Cards 15.80% --0.00 15.80%
Cash Back Cards 16.42% --0.00 16.42%
Low Interest Cards 11.09% --0.00 11.09%
 
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