959. Laura answers a listener's question about the best way to pay off credit cards when you have little or no extra income.
959. Laura answers a listener's question about the best way to pay off credit cards when you have little or no extra income.
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Welcome back to Finance Friday, another special edition of Money Girl, where I answer your burning money questions! Today's topic comes from Greg, who says:
"I have a relatively small mortgage of about $275,000, but I recently made some renovations and had to charge about $30,000 for materials and labor on credit cards. My lowest card interest rate is about 13% and I’m trying to pay off the balances as quickly as possible. Since I don’t have much extra money to send each month, what’s the best way to manage this debt?”
Thanks for your question, Greg! I’m sure many people can relate to your struggle to pay off credit cards when money is tight. The best approach to handling card balances depends on various factors and your goals. This post will review strategies for minimizing interest and eliminating credit cards depending on your financial situation.
Welcome back to episode 959 of Money Girl–I appreciate you downloading the show! I'm Laura Adams, an award-winning author, on-camera spokesperson, female money speaker, and founder of The Money Stack, a Substack newsletter.
You can learn more, ask any money question, and sign up for the Money Stack at LauraDAdams.com. You can get the newsletter for free or become a paid member with access to my live educational and Q&A events. Additionally, you can ask a money question by leaving a voicemail at 302-364-0308.
8 tips to pay off credit cards when money is tight
Credit cards are flexible financial tools that allow you to borrow money for everyday expenses or to finance larger purchases. However, they also have a downside because many cards charge very high interest rates, such as 25% to 30% or more. That’s why carrying card balances for long periods is generally not wise.
The problem is that if you can only make a card’s minimum payment, you’ll maintain good credit, but rack up lots of financing charges. As high interest gets added to your card each month, you must pay interest on a growing balance. That can make getting out of credit card debt especially difficult.
The optimal way to use credit cards is to make charges that you can afford to pay off in full each month. That allows you to get many conveniences and rewards from card issuers for free.
However, I know that there are times when using a credit card to finance a planned purchase, such as a renovation, vacation, or furniture, can be the easiest option. If you must finance charges on credit cards, here are eight tips for paying them off, even when you have a tight budget.
1. Use your lowest interest card.
If you have multiple cards, be aware of their interest rates before making large charges. Cards typically have variable interest rates that fluctuate based on an index, such as the prime rate. Therefore, card rates can increase or decrease over time.
When you must carry a balance, do it only on your lowest rate card(s). They typically won’t be rewards cards that offer lots of nice perks, such as travel points or cashback rewards. Cards that don’t have lots of benefits are likely to charge you less interest than rewards cards.
If your only card has a high interest rate, such as over 20%, consider shopping around for a lower rate option. Your offers will depend on factors like your credit and income. You can also contact customer service for any existing cards and request a lower rate to help pay off your balance faster. The worst they can say is no!
Greg mentioned that his lowest rate card is about 13%, which isn’t too bad considering that the average is over 20% right now. If he can reduce the rate or transfer higher-rate balances to that card, it would be a win. I’ll talk more about balance transfers in a moment.
2. Stop adding to card balances.
The first step to getting out of credit card debt is to stop making new charges you can’t fully pay off each month. Greg didn’t mention if he has more renovations to make or if he’s using his cards for other purposes.
But if you can’t pay off current purchases, it will likely be a while before you can pay off older balances. Consider ways to earn extra income, such as starting a side gig, finding a better-paying job, asking for a raise, taking on a second or seasonal job, or selling unused items, so you can pay more towards your card balances.
Additionally, look for ways to significantly reduce costs so you can eliminate debt more quickly. Challenge yourself to eliminate all unnecessary expenses for at least a few months and shop for better deals on your recurring bills, such as auto insurance, wireless plans, and subscription services, to save money.
READ ALSO: 10 ways to save money on car insurance
3. Pay more than a card's minimum.
Many people who can pay more than their monthly card minimums don't do it. The problem is that minimum payments primarily go toward interest and don't reduce your balance.
For example, if your card charges a competitive 15% APR, you have a $5,000 balance, and your minimum payment is 4% of the balance, it will take you 10.5 years to pay off the balance if you never use the card again. And here's the worst part--you'd have paid almost $2,400 in interest! That's a conservative example because, as I mentioned, many people are paying rates over 20%.
So, no matter how tight your budget is, push yourself to send more than a card’s minimum payment each month.
4. Create a debt payoff plan.
To create a debt payoff plan, list all your debts, including credit cards, lines of credit, mortgages, and loans. You might jot them down on paper, enter them in a Google sheet, or use my Personal Financial Statement (PFS) template, which is a free download when you subscribe to my weekly newsletter, The Money Stack.
Using my PFS will prompt you to include your balances, interest rates, and payoff dates for installment loans. Then, you'll rank your debts from highest to lowest interest rate for a payoff priority.
Remember that the higher a debt's interest rate, the more it costs you in interest per dollar of debt. Therefore, eliminating the highest-interest debts first yields the greatest savings. Plus, you can use the savings to pay more on your next highest interest debt, allowing you to get out of debt faster.
If you have several credit cards, rank them the same way--from highest to lowest interest rate. However, if a credit card isn't the most expensive debt you have, or you have other dangerous debts, it should be lower on your priority list.
Generally, debts with tax deductions, such as mortgages, home equity lines of credit, and student loans, should be paid off last. Not only do they charge relatively low interest rates, but they cost even less on an after-tax basis, provided you claim a tax deduction for them.
5. Use your assets to pay off cards.
If you have assets, such as savings and non-retirement investments, that you can use to pay down high-interest credit cards, that may make sense. Remember that you still need a healthy cash reserve in the bank, such as several months' worth of living expenses.
If you don't have any or enough emergency money, don't dip into your savings to pay off credit card debt. Additionally, consider selling tangible assets, such as unused sporting goods, jewelry, or a vehicle, to raise cash and increase your financial cushion or reduce your credit card balance.
6. Consider a balance transfer offer.
If you can't pay off credit card debt using existing income or assets, consider "optimizing" it by moving it from a higher to lower-interest option utilizing a balance transfer credit card. It temporarily reduces the interest you pay, giving you some financial breathing room.
You apply for a promotional offer, such as paying 0% interest for 12 months. Every transfer is subject to a fee, typically 4% or 5%, which is added to your balance.
By transferring higher-interest debt to a zero-interest credit card, you avoid interest and save money to pay the balance faster. However, the amount you can transfer depends on the credit line the issuer offers you. If you don't have good credit, you may not be approved for a balance transfer or may only be able to transfer a small amount of your debt to a transfer card.
I recommend always paying off a balance transfer before the promotion expires. For instance, if you are approved to transfer $6,000 to a card charging 0% for 12 months, you should make monthly payments of at least 1/12 or $500, so it gets eliminated before your interest rate increases.
READ ALSO: Benefits and drawbacks of credit card consolidation
7. Consolidate your high-rate balances.
A common question I receive about credit cards is whether it's wise to consolidate balances. Many people worry that consolidation is a scam or will hurt their credit.
Debt consolidation is a legitimate way to shift higher-interest debt to a lower-interest account. While it may seem counterintuitive to use new debt to get out of old debt, it all comes down to your interest rate and payment.
Depending on the terms you are offered, consolidating can be an excellent way to reduce interest and pay off debt faster. No, it doesn't reduce the debt you owe, but transferring or reorganizing it can reduce your interest rate and make it easier to pay off.
The most common form of debt consolidation is using a fixed-rate personal loan to pay off higher-interest-rate debt. You make monthly payments over a set repayment term, typically three or five years. The rate and terms a personal loan lender offers typically depend on factors such as your income and credit.
Remember that even though a personal loan may cut your interest, the shorter your repayment schedule, the higher your monthly payments will be. You risk harming your credit if you fail to repay a personal loan as agreed.
You can enter basic information at an online lender like Lightstream to see your loan options without hurting your credit. A consolidation loan is a good option when you have a larger balance to consolidate and want a structured repayment term.
For example, if you have a credit card balance charging 22%, paying it off with a 12% fixed-rate personal loan over three years allows you to save a lot of interest over a set repayment schedule.
In addition, having an additional loan added to your credit history helps you build credit if you make payments on time. Consolidating your debt also works in your favor by reducing your credit utilization ratio when you pay off your credit card debt. So, a loan consolidation generally helps your credit and doesn’t hurt it.
8. Take out a home equity line of credit (HELOC) or loan.
If you're a homeowner with at least 20% equity, you may qualify for a HELOC or equity loan. For example, if your home's market value is $400,000 and your outstanding mortgage balance is $300,000, you have $100,000 in equity or 25% ($100,000 / $400,000 = 0.25).
A HELOC is a revolving line of credit with a variable interest rate that allows you to borrow an amount up to your credit line, using your home as collateral, without needing to refinance your existing mortgage. A home equity loan gives you a lump sum to repay over a set term, such as five to thirty years, with a fixed interest rate.
Since a HELOC and equity loan are secured debt, they typically charge lower interest rates than a personal loan. You can use them however you wish, such as for home renovations or paying off higher-rate debt.
However, if you use a HELOC or equity loan to buy, build, or improve your home, a portion of the interest paid is tax-deductible—but that's not the case for other uses like debt consolidation.
The main downside of tapping your home equity with a HELOC or loan is that if you default, you risk losing your home to foreclosure. Additionally, there are closing costs, similar to those associated with a primary mortgage, which contribute to the overall cost of borrowing. Consider getting multiple quotes, including from your current mortgage lender.
Greg mentioned having a $275,000 mortgage, but didn’t reveal a home equity amount. If he has enough equity, using a HELOC to pay down card debt could make sense. But he wouldn’t be eligible for a tax deduction on home improvement expenses that were already paid for with a credit card.
However, if Greg does more home renovations in the future, getting a HELOC to pay for them would cut interest compared to using a credit card and allow him to claim a tax deduction for the interest.
LISTEN ALSO: Pros and cons of a home equity line of credit (HELOC)
Should you cancel paid-off credit cards?
If you use these strategies to pay off one or more credit cards, you may wonder what to do with them. If maintaining good credit is one of your goals, I recommend keeping paid-off cards instead of canceling them. To maintain or improve your credit, you must have credit accounts open in your name and use them on a regular basis.
Making small purchases from time to time and paying them off in full and on time is enough to add positive data to your credit reports. You don't need to carry a balance from month to month or pay interest on a credit card to build excellent credit.
Greg, thanks again for your question! If you can get a no-interest balance transfer, lower-interest loan, or HELOC for some or all of your credit card debt, you’ll save money and create a clear path for eliminating it as quickly as possible.
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That's all for now. I'll talk to you soon. Until then, here's to living a richer life!
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