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Wednesday, August 26, 2009

8 things you must know about credit card debt

8 things you must know about credit card debt

Despite what you may hear about credit cards, getting into overwhelming debt with them is not inevitable. In fact, millions of credit customers charge regularly and never pay a penny in finance charges or other fees. Here's how you too can use plastic to your advantage: 1. You don't have to owe! 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, says Purdue University's Elizabeth Kiss, who holds a doctorate. in family and consumption economics. "Write all credit activity in a checkbook register," says Kiss, "and constantly update your balance."

2. Know when short-term loans make sense. Sometimes financing a purchase with a credit card is prudent -- as long as the repayment time frame is short. For example, 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. If you stretched it out over two years, however, you'd pay an extra $300 -- quite a mark-up.

3. Owing is easy, repaying is hard. Without careful attention, sinking into overwhelming debt is remarkably easy. "Most people get into trouble gradually," says Kiss, explaining that when cardholders start out, their credit card limit is usually low. Over time it typically rises, which makes overcharging tempting. "Then you wake up and ask, ‘What did I buy, what did I do?'" Kiss says. 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.

4. Debt affects your credit score. Not only is it wise to remain debt free for your own bottom line, holding onto high balances negatively impacts your credit score. To maintain a high score, your account balance should be under 35 percent of your available credit limit, says Lucy Duni, vice president of consumer education at by TransUnion. Therefore, if you have a credit line of $1,000, owing less than $350 is optimal. Timely payments are also vital. If you fall behind and skip a billing cycle, your creditor will report a 30-day delinquency to the three major credit reporting bureaus (TransUnion, Equifax, and Experian) and your score will drop noticeably. Miss more and you'll see a dramatic downturn in your credit score.

5. 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 card's interest rates.
  • Prioritize payments by interest rates (pay the high-interest balances first).
  • Suspend charging while in repayment mode.

6. Can't make a payment? Ask for help. 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.

7. 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, settlements should only be attempted 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."

8. You can't go to jail for nonpayment, but... If you're worried about spending time behind bars for not paying your credit card debt, know that there is no debtor's 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. Living debt free is within every cardholder's capability. The key is to always be aware of charging and balances, and address credit problems immediately.

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