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Debt Management

What is credit card debt?

How it happens – and how to make sure it doesn't happen to you

Summary

Credit card debt is a problem for many, but it doesn’t have to be a problem for you. Here’s how it works and how to avoid it.

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Credit card debt is an ongoing problem for many people. But getting into overwhelming debt with credit cards is not inevitable.

In fact, millions of credit customers charge regularly and never pay a penny in finance charges or other fees. Here’s what you need to know about credit card debt so you, too, can use plastic to your advantage – not your detriment.

Credit cards are a type of revolving loan offered by the issuing bank. Anything you don’t pay off in the monthly statement period carries over to the next statement and incurs interest. Credit card debts have higher interest rates than rates for other types of loans. This is because they’re unsecured debts, unlike mortgages or car loans, in which the lender can seize property if the debt is unpaid.

How credit card debt works

Without careful attention, sinking into overwhelming debt is remarkably easy. When cardholders start out, their credit limit is usually low, but over time it rises – which makes overcharging tempting.

Paying down debt is difficult because as the balance climbs, the interest compounds and payments increase. With funds promised to past spending, less money is available for current and future expenses.

How to avoid credit card debt

Here’s what you need to do to avoid the pitfalls that lead to credit card debt:

Charge what you can afford to pay

It is entirely possible to use credit cards regularly and stay out of debt forever. How? By only charging what you can afford to pay when the bill arrives. Use credit cards as a payment tool, not as a revolving debt instrument. To make this method work, you’ve got to track charges and cash flow.

Financing a purchase with a credit card can be prudent if the repayment time frame is short. Let’s say you want $1,500 worth of living room furniture, but don’t have the cash to pay for it immediately. If you charge the items to a credit card with an 18 percent interest rate, and cover the balance in four months, the finance fees would total just $57. Not a bad deal. But if you stretched it out over two years, you’d pay an extra $300 – quite a markup.

Pay your balance on time every month

Not only is it wise to remain debt free for your own bottom line, holding on to high balances negatively impacts your credit score.

To maintain a high score, your account balance should be under 30 percent of your available credit limit, says Lucy Duni, a consultant that works with TransUnion. And many personal finance experts advice keeping your credit utilization as close to zero as you can.

Timely payments are also vital. If you fall behind and skip a billing cycle, your creditor will report the delinquency after 60 days to the three major credit reporting bureaus (TransUnion, Equifax and Experian) and your score will drop noticeably.

Miss more payments and you’ll see a dramatic downturn in your credit score. And those negative marks don’t fall off your credit reports for a full seven years!

Develop a repayment plan

Even if you’re in deep, you can probably climb out of debt with commitment and a plan. Norman Perlmutter, author of “How To Settle Your Debts,” suggests going into “crisis money management mode”:

  • Limit spending to basic needs to free up cash to pay down debt.
  • Ask creditors if they will reduce your cards’ interest rates.
  • Prioritize payments by interest rates (pay the high-interest balances first).
  • Suspend charging while in repayment mode.

Ask for help if you can’t make a payment

While your credit card company is under no obligation to accept less than the minimum requested payment, do not fear. “Try to work with your credit card company to work out payment agreements,” urges Lita Epstein, author of “The Complete Idiot’s Guide to Improving Your Credit Score.”

“If that’s unsuccessful, work with a credit counselor from the National Foundation for Credit Counseling to come up with a repayment plan,” she says.

Ask for forgiveness – but settle cautiously

Want to settle your credit card debt for less than the actual balance? It’s possible, but you need to offer a lump sum, and most creditors require borrowers be at least a few months behind.

Arranging such a deal on your own is best, as companies that facilitate it often charge a substantial fee and some aren’t very reputable. Still, you should attempt a settlement only after less radical steps to eliminate debt fail, as they can result in substantial credit damage and tax problems.

“Forgiven debt is often reported as taxable income,” says Perlmutter, “and unless it resulted from a bankruptcy or your debts were greater than your assets when you made the settlement, you will have to pay tax on it.”

Address credit problems immediately

If you’re worried about spending time behind bars for not paying your credit card debt, know that there is no debtors’ prison in the United States. However, there are other legal repercussions of which you should be aware.

A creditor can sue you in a court of law, and if they win a judgment, they may be able to garnish your wages or take nonexempt property and assets.

Bottom line

Credit card debt is a problem for many people, but it doesn’t have to be a problem for you. Living debt-free is within every cardholder’s capability. The key is to always be aware of charging and balances – charge only what you can afford, pay your balances on time. When credit problems arise, address them immediately.

Editorial Disclaimer

The editorial content on this page is based solely on the objective assessment of our writers and is not driven by advertising dollars. It has not been provided or commissioned by the credit card issuers. However, we may receive compensation when you click on links to products from our partners.

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