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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 one 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.

Issuing banks offer credit cards as revolving loans, and any part of the balance you don’t pay off in your monthly billing statement carries over to the next statement — and incurs interest. Credit card debts have higher interest rates than for other types of loan rates because they’re unsecured debts, meaning there is no collateral for the lender to seize should you fail to pay.

Here’s what you need to know about credit card debt so you can use your cards to your advantage instead of detriment.

How credit card debt works

Sinking into overwhelming debt is remarkably easy. When you start out, your credit limit is usually low, but over time it can rise if you pay on time, every time — and that can make overcharging tempting.

Paying down debt is difficult because as the balance climbs, the interest compounds and payments increase. And when your funds must go toward paying off your previous spending, less money is available for your current and future expenses.

These are a few ways you can make progress toward paying off credit card debt:

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

You can definitely use credit cards regularly and stay out of debt forever. How? By charging only what you can afford to pay. 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 to buy $1,500 worth of living room furniture but don’t have the cash to pay for it. If you charge the items to a credit card with an 18 percent interest rate and pay off the balance in four months, the finance fees would total just $57. Not a bad deal. But if you pay it back over two years, you’d pay an extra $300 — and that’s quite a markup.

Pay your balance on time every month

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

To maintain a high score, your account balance should be less than 30 percent of your available credit limit, says Lucy Duni, senior director, online marketing for TransUnion. And many personal finance experts advise 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.

Ask for help if you can’t make a payment

While your credit card company is under no obligation to accept less than the requested minimum payment, do not fear. “Try to work with your credit card company to work out payment agreements,” says 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 will do it only for borrowers who are at least a few months behind.

Arranging a deal with your card issuer on your own is best, because 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 it can result in substantial credit damage and tax problems.

“Forgiven debt is often reported as taxable income,” says Norman Perlmutter, author of “How To Settle Your Debts.” And unless it “resulted from a bankruptcy or your debts were greater than your assets when you made the settlement, you’ll have to pay tax on it,” he added.

Address credit problems immediately

It is essential to address any credit issues immediately because if you don’t, there will be legal repercussions. 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.

How to pay off credit card debt

There are several ways to pay off credit card debt.

  • The avalanche method involves paying off credit cards with the highest APR first to save as much as you can on interest.
  • Another way to pay down debt is through the snowball method, which focuses on paying off the cards with the lowest balances first instead of paying off the highest APR cards.
  • You can also use a couple of different debt consolidation strategies, including getting a balance transfer card and taking out a debt consolidation loan.

Bottom line

Credit card debt is a problem for many people, but it doesn’t have to be one for you. Living debt-free is within every cardholder’s capability. The key is to always be aware of what you’re charging and what your balances are. A good rule of thumb is to  charge only what you can afford and always pay your balances on time. Also, if and 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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