There’s no downplaying the benefits of paying off a credit card. You can free up cash, improve your credit score and enjoy peace of mind. And since there is no one-size-fits-all approach, different management strategies can reduce and ultimately eliminate balances. For example, some people pay off their highest balances first, whereas others start with cards that have the highest interest rate. To each his own.
But although there are no specific rules for managing credit card debt, some moves may not prove as effective.
- Wiping out your emergency fund
- Getting caught in the minimum payment trap
- Not asking for a better interest rate
- Leaving creditors in the dark
- Tapping your home’s equity
If you have cash in your savings account, you may consider dipping into this account to clear your credit card debt. This is certainly effective, as you can possibly eliminate balances today. But don’t act so quickly.
An emergency savings account is just that – an emergency account. And while paying off credit card debt is a priority, you shouldn’t pay off debt at the expense of your savings.
Think about this, if you wipe out your bank account to pay off a credit card, how would you handle an emergency?
Of course, the decision to dip into your savings account really depends on how much you have in the account. For your protection, you should maintain at least a three-month cash reserve. If you’re able to pay off your credit card debt while maintaining an adequate cash reserve, only then should you dip into your emergency fund.
Your credit card company may only require a $20 or $25 minimum payment each month, and this payment might fit perfectly in your budget. But if you owe thousands on a credit card, you’ll barely put a dent in your balance.
Credit card companies want to make money, and a minimum payment is their way of keeping you in debt. The longer you owe the balance, the more they receive in interest payments. To make any real progress, you have to increase monthly payments.
A lump sum payment each month is your best bet for eliminating balances quickly. But if you are unable to drop $200 or $300 on a credit card, start by doubling or tripling your minimum payments.
A high interest rate can slow down any efforts to pay off a credit card. If you’re paying down your balances, and you’ve been making timely payments, give your credit card company a ring and ask for a better interest rate. The will either say yes or no, but with a solid track record, the odds are on your side.
Although a lower rate can reduce how much you pay in interest and your minimum payment, you shouldn’t decrease how much you pay each month. Continue to send higher payments as normal. Since you’re paying less interest, the majority of these monthly payments will go toward bringing down your principal balance, helping eliminate the balance quicker.
If you cannot pay your credit card bill, the worst thing you can do is leave your creditors in the dark. Credit card companies charge a late fee if payments are not received by the due date. And if your payment is more than 30 days late, they can report the delinquency to the credit bureaus.
But if you notify your creditor of payment problems, you can avoid all of this. Creditors aren’t the devil, and many will work with you if you experience hardship. They may extend your due date, reduce how much you owe or allow a skip payment. However, before they can offer any provisions, they have to know your situation.
A home equity loan is a way to consolidate and pay off your credit card, at which time you repay the lender at a lower interest rate. This could be a smart move if your new payments are lower than your previous minimum payments. However, tapping your home’s equity to pay off credit card debt only works if you have self-control.
Once your credit cards are paid off, you will have a ton of available credit at your disposal. If you don’t destroy these cards or close these accounts, you could use these accounts again and accumulate a ton of new debt – while you’re still paying on a home equity loan. This puts you right back in the same situation, only this time your house is on the line. Defaulting on a home equity loan puts your home at risk for foreclosure.