Paying down your credit card balance will reduce your monthly minimum payment due. However, if you’re trying to get out of debt, paying only the minimum is a poor plan – especially since cards tend to have high APRs. Here are some strategies to reduce your debt.
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Dear Keeping Score,
I received my retirement money finally. I want to pay down my credit cards. If I pay half the balance will the monthly payment also be reduced? —Gwen
If you’ve just received your retirement money, chances are you are wise in the ways of the world. But my experience tells me that does not always equate to personal financial expertise.
So, before I answer your question I have to ask if you’ve considered the effects of spending a chunk of your retirement savings all at once, instead of keeping it invested and making periodic payments.
All things being equal, it is smart to protect your cash in retirement, as it’s hard to replace. Later on in this column I’ll suggest alternative payment options to avoid the high interest rates charged by credit cards. But first, on to your question:
The short answer is yes, cutting your balance in half will reduce your monthly minimum payment due. It might not cut the payment in half, but your payment would be substantially reduced. A 50 percent payment on a large balance would give you closer to 50 percent payment reduction than a similar percentage payment on a smaller balance.
Why paying only the minimum is dangerous
I have another question for you – have you only been paying the minimum amount due on your credit cards?
Using credit cards as a financial tool to stay ahead of your monthly obligations is simply not a sustainable practice. Unfortunately, far too many consumers have done this. Then they, like you, find themselves at the end of their working lives owing thousands of dollars to credit card companies and using their hard-saved retirement dollars to pay bills accumulated over the years.
Ideally, retirement money is meant for tomorrow, not yesterday. But what’s done is done, so let’s see if I can offer some advice that may help you going forward.
Minimum payments are calculated on the outstanding balance of your credit card and are usually 1 percent plus monthly interest and any fees. To find out what your cards are charging you, take a look at your statements. There is a wealth of information to be found on that monthly missive from your creditors. Not only can you discover how the minimum payment is calculated, you can find out the interest rate you are being charged.
In addition, there will be a box on your statement telling you something like this: “If you make only the minimum payment each period, you will pay more in interest and it will take you longer to pay off your balance.” Then it will show you how incredibly long it will take to pay off your balance if you pay only the minimum and how long it will take if you pay a certain amount more than the minimum. Finally, it will tell you how much you will end up paying in total for both scenarios. This little box is quite the eye-opener.
How to avoid credit card interest charges
Remember what I said above about adding to your balances? The box on your statement assumes no additional charges will be made. This is important. So, here are a couple of things I suggest to help you get out from under the high interest rates credit cards charge.
Get yourself a new credit card with no balance and keep it that way. Every time you make a purchase on a card that is carrying a balance from a previous month, the new charge begins to accumulate interest before you leave the store.
This will make it much harder for you to ever get out of debt. Using a new card that you pay in full each month will stop this silliness from taking even more of your retirement money and unnecessarily giving it to a creditor.
It will also help you boost your credit score. After a month or two of a small decline from opening a new account, you should see your score rise. This will be for two reasons: first, you will be paying down the balance on your old cards and second, you will have a new line of credit. These two factors will decrease your overall credit utilization rate, which is worth 30 percent of your FICO score.
You could also transfer your remaining balance to a new card with an introductory 0 percent APR. But keep in mind that balance transfers often come with a 3-5 percent fee. Also, you’ll want to be sure you can pay the entire balance off before the promotional period ends, otherwise your remaining debt will be subject to the card’s regular APR.
If you are a homeowner, look into a home-equity loan or line of credit. Paying off the other half of your credit card debt using these funds will lower your interest rate significantly. But you will need to be extremely careful to always make the monthly payment, as this type of loan is secured by your residence.
How to pay off your remaining card debt
Here is how I would suggest you begin. Take a hard look at:
- The money you have now
- Your post-retirement goals
- The expenses you will continue to have in retirement
If you cut your card balances in half as you are suggesting, you are also going to need to determine how much you can afford to pay every month to tackle the remaining balance. This will need to be more than the minimum due if you are going to make any real progress.
Once you have that number, plug it into your monthly spending plan as a fixed cost. Yes, I think you need a monthly spending plan or budget. What that means is that if you decide you can afford to pay $300 a month, you need to pay $300 every month.
The sneaky thing about minimum payments is just what I said in the beginning. As your balance goes down, so does your minimum payment. You need to ignore that and stick to paying a set amount every month.
Also, this kind of goes without saying, but I’m going to say it anyway – you must stop using your cards as extra income. What I mean is that if you use your new card to, for instance, fill up your car one week at a cost of $40, then you need to pay off the $40 charge at the end of the billing cycle. No fudging!
Getting out of debt takes discipline
I’m not going to kid you – getting out of credit card debt takes discipline, just like saving for retirement did, but you’ve done this before and you can do it again. CreditCards.com has some handy calculators that can illustrate this for you as you are looking at your statements.
If this all seems too overwhelming to you or if the numbers just don’t work out, I suggest a call to a certified nonprofit credit counselor. That little box on your statement will also include a number you can call about credit counseling, but my suggestion would be to use a member affiliated with the National Foundation of Credit Counseling. All their members are local nonprofit organizations that have passed rigorous third-party accreditation.
The sooner you can get a handle on all of this, the sooner you will be able to breathe easier and enjoy your retirement.
Remember to keep track of your score!