Kiss That Plastic Bye-Bye
Fat credit card debt is as much a part of the holidays as Santa. Here's how to shed it and get your ho-ho-ho back
Every year at this time, Americans vow to shed two things: the extra pounds they pack on after feasting on too much turkey and the extra credit card debt they rack up on gifts for friends, family, and themselves. In fact, consumers are expected to ring up $135 billion more on plastic during the holiday season.
Yet before you head out to the mall this year, keep something in mind: Reducing debt is going to be harder than trying to drop a few unwanted pounds. After all, even if you, well, go cold turkey on shopping after the holidays, your debt will continue to grow, thanks to compounding interest.
"When interest rates were declining, it was supposed to be a great tail wind for consumers to repay their debt," says Greg McBride, senior financial analyst with Bankrate.com. "Instead, they took on even more debt."
Indeed, the average consumer is nearly $12,000 in the red-not counting mortgage debt-according to the credit bureau Experian.
Unfortunately, there is no Atkins diet for debt that will allow you to have your steak and eat it, too. At the very least, make sure you don't wade any deeper into the red. The average adult is expected to spend $857 on holiday gifts this year, according to the market research firm GfK NOP. See if you can keep well under that level.
Charge it! Not. One way to maintain discipline is to load your holiday spending budget onto a prepaid card, like those offered by Visa or MasterCard. There will be a slight fee, but by doing all your gift shopping on the card, you'll know exactly how much money you have left.
Another option: Buy with cash only. Studies show that consumers who use plastic for a purchase are likely to spend about a third more than if using cash.
"Reducing debt means looking seriously at the debt and changing your lifestyle so you are not spending more than you are earning," says Dee Lee, president of Harvard Financial Educators. The only way to tackle it is to chip away at your mountain of debt little by little, she says.
Consider the $20 rule: Try increasing the amount you set aside each week for debt repayments by at least $20. Surveys show that the vast majority of Americans can save an additional $20 per week. By committing $20 a week toward debt reduction, you'll cut your obligations by an extra $1,040 a year.
To really get a handle on your debt, put together a budget. Figure out exactly how much you spend each month in various categories, such as food, shelter, and entertainment. "Literally do what companies do," says McBride. "At the end of the month, add up what you spend, what you earn, and compare the two figures."
Why not take this analogy one step further? Act like a business, and impose temporary across-the-board cuts in discretionary spending when you find yourself in dire straits. Obviously, you can't easily reduce your rent or monthly loan payments. But you can certainly try to trim, say, 10 percent from spending on entertainment, travel, clothing, and dining out.
Which debt should you pay off first? "You have to prioritize your debt," says McBride. Start with what planners refer to as "bad debt," including revolving lines of credit, such as credit card balances. Remember, interest payments on credit card balances are not tax deductible. But interest on student loan debt is, depending on your income. And student loans typically carry low interest rates compared with credit cards. Interest on home equity loans and mortgages is also usually tax deductible, so wait to settle those last.
Common sense says to clear the highest-rate card first. After all, if you pay off $1,000 on a card charging 21 percent interest, it's the equivalent of earning 21 percent on that money.
But if you have a slightly higher-interest card with $20,000 owed and a lower-rate card on which you owe, say, $1,000, you might consider paying off the $1,000 card first. By eliminating one card's balance completely, you might feel emboldened to tackle the rest.