Let’s stop ignoring $1.3 trillion in credit card debt owed by millions of Americans. Perhaps including by you. Even if you stop buying, balances grow like a cancer, because the average annual interest rate on credit cards is 20.75%, according to Bankrate (many cards now charge 29% or higher). In most states, credit card rates are not subject to usury laws that set caps on consumer borrowing rates.
Depending on your card issuer, if you pay only the minimum monthly balance you could be paying for 10 years or more, with interest totaling double the amount you originally charged!
So, what can — and should — you do? You’ll read and hear a lot of advice for getting out of credit card debt. Unfortunately, some of the popular recommendations will only make your debt problem worse. Below I list some of the more popular strategies, and I’ve graded them ranging from A to F.
—Borrow from your 401(k) plan: Grade F
Don’t do that! If you think it’s tough to be in debt now, it will be even more painful to be poor in your old age! You won’t earn money on your plan investments while the money is borrowed out of the plan — if your employer even allows loans in the first place. Even worse, if you quit or lose your job with a loan outstanding, it will be considered a withdrawal, subject to taxes and penalties.
—Payday loans: Grade F
These loans are the quicksand of financial debt. They carry exorbitant interest rates, trapping you in a cycle of growing balances.
—Credit card consolidation offers: Grade D
If you’re paying the minimums, your credit remains in reasonably good standing, although you’re in a state of panic. But most of these fix-it programs require you to stop paying on your card debt and to set aside the money you would have paid so the fixers can negotiate a “deal” with the card issuer or debt collector. This process ruins your credit, and with some debts, a lender can file a lien against your home or attach your wages.
—Personal loans: Grade C
There are many online lenders like SoFi and Upstart that offer to give you a personal loan with an interest rate far lower than the ones on your credit cards. But there are fees as well as interest charges on these loans, and they may require a certain credit score. Even worse, some have balloon payments in a few years, requiring you to pay off the balance in full. Compare several lenders at Credible.com.
—Home equity loan or line of credit: Grade C
Now you’ve put your home on the line, because the interest on these loans is so much lower than on your credit card. Beware. You may be making affordable, lower monthly payments because you’re paying only the interest! And at the end of five years, there could be a “balloon” payment due.
—Balance transfer cards: Grade B
Here’s your chance, likely your one chance to really make a dent in your debt — if you handle the process wisely. Search for a balance transfer card at CreditCards.com or Bankrate.com. You’ll find one that offers as much as 21 months of zero interest on the balance. Of course, there are fees that go along with this service, and they are rolled into the balance. Make sure you use that interest-free period to pay down your balance, or you’ll be trapped. The zero rate jumps to 30% or more at the end of the grace period, leaving you in a deeper hole.
—Double the minimum strategy: Grade A
If you make double the current minimum payment due, and pay the same amount every month (not double the new minimum), without charging another penny, you’ll pay off that balance in less than three years!
There is one critical caveat to all of these strategies: When your current credit card balance is paid off, there’s a temptation to keep that card — just for “emergencies.” You should immediately close the now paid-off card. Yes, it may ding your score if it is a long-held card. But it’s best not to leave temptation in your wallet.
And if you’re totally overwhelmed with debt of all kinds, contact the one trusted source of help — the National Foundation for Credit Counseling. Call 800-388-2227. It will connect you to the nearest member agency. Fees are minimal and their advice is priceless.
The debt law of holes is, “When you’re in a deep hole, stop digging!” And that’s The Savage Truth.
(Terry Savage is a registered investment adviser and the author of four best-selling books, including “The Savage Truth on Money.” Terry responds to questions on her blog at TerrySavage.com.)