Post-holiday debt: The real cost
By Ben Woolsey and Emily Starbuck Gerson
Credit card debt is an epidemic in the Western world, most notably in the United States. The combination of large outstanding balances, penalty pricing and late fees often conspires to keep consumers in a vicious cycle. It doesn't help that 74 percent of Americans put holiday gifts on their credit cards, according to a 2006 survey by the Family Credit Counseling Service.
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Manisha Thakor, co-author of "On My Own Two Feet," a personal finance guide for young women, has a master's degree in business from Harvard and extensive experience in the financial services industry. Most Americans lack a solid grasp on their finances, she says, citing the American Payroll Association's statistic that 70 percent of Americans live paycheck to paycheck. "It's not that people want to make bad decisions, it's just that personal finance, like parenting, is one of those things you are expected to pick up along the way. Layered on top of this is easy access to credit and a barrage of media messages telling you to shop now, bigger, faster, and you have the financial equivalent of a perfect storm."
In the past, Thakor says, people were limited by the cash they had on hand, and could only get a loan by going into a bank and telling a loan officer what it was for and how they would pay it back. Today, almost anyone can get a credit card and spend money they don't have. "The holidays tend to exacerbate all of these urges because it's so easy to shop to fight either loneliness or angst, or because you justify it because you are 'giving' the gifts to others," Thakor says.
Living above one's means with a credit card can lead to trouble. If you buy a $2,000 computer for your spouse and already have an outstanding balance, you won't be allowed a grace period on that new purchase. You will start paying interest from day one. If your low introductory interest rate has expired, you will probably be paying upward of 14 percent. If you pay only the minimum, you will be paying little, if any, of the principal amount. Essentially, you will continue paying the same rent charge on that borrowed $2,000 for years in perpetuity. Sounds a bit frightening, doesn't it?
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Do not look for a quick fix and sign up for an unscrupulous debt consolidation program, Thakor says. "Debt consolidation doesn't address your root problem -- your spending habits -- which got you into the hole to begin with!" She says it is important to earn more and spend less. Take on extra work such as a temp job or delivering pizzas if you have to. "It's just like losing weight -- no matter what you call it, all diets boil down to exercising more and eating less," Thakor says.
John Mruz is president of Juggling Duck Organizers in Morristown, N.J. His company sells a paper-based financial organizer that helps consumers make educated money decisions and learn how to get out of debt. Mruz paid down six figures worth of educational loans, which inspired him to start his own company. He shares the method he used:
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- Assess how much debt you have on each card, and what interest rate each card carries. "You should also note whether any of your cards offer a special funds transfer offer, such as transferring your outstanding balances and getting a 6 percent interest rate for six months," Mruz says.
- Stop spending. "With your credit card company charging interest at the rate of 20 percent to 30 percent per year, you simply cannot afford to run up any more charges until you are able to pay down all of your balances," Mruz says. Pay for things in cash, and before you make a purchase, ask yourself if you really need it. Forgo instant gratification.
- Set up a monthly budget, and treat your credit card payments as a high priority. First, establish your expected monthly take-home pay (don't forget about taxes and other deductions) and allocate the rest for expenses such as food, entertainment and gifts. "In this case, you must treat your credit card payments as a required expense, right up there with your rent, because if you do not get these credit card bills under control, you might find yourself choosing between the two," Mruz says. "Figure out a reasonable amount that you can afford to pay each month and skim it off the top before you have a chance to spend it."
- Figure out in what order the cards should be paid off. See if you can transfer any or all of the balances from your higher interest cards to a lower interest card -- many balance transfer cards provide 0 percent introductory APR for up to 12 months. "Then, take whatever money you have allocated to debt reduction, pay the minimum payments on the other cards and apply whatever leftover you have to the card with the highest interest rate," Mruz says. "That is where your maximum benefit will be achieved."
Mruz says consumers should avoid getting in debt. "Before you set foot in a mall or visit your favorite online retailer, you need to know how much 'holiday' you can afford this year."
Once you determine an amount, make a list of everyone you need to buy gifts for and allocate your holiday budget accordingly. "If you stick to a budget on everyone on your list, amazingly, you will hit your overall holiday budget and minimize your post-holiday debt."
Published: January 3, 2008
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