Most people intend to pay off their credit card balance every month. In reality, 60% of people carry a balance on their credit card every month. The 40% of people who are able to pay off their cards have an iron resolve when it comes to budgeting and are able to anticipate their cash flow perfectly. For the rest of us, paying rates in the high 20% and low 30% range is both an insult and financial suicide. Luckily, there are ways to reduce the amount of interest that you pay. If you carry a balance on your card, this article should help save you a few dollars.
Monthly Interest Cost
Do you remember when you first applied for your credit card? Chances are that you picked a card with the lowest annual fee. This is a great strategy for those who don't carry a balance, but for the 'other 60%', the rates charged on the 'no fee' cards are prohibitive. The monthly interest charge on $1,000 at 28.9% is $24.08. This may not seem all that outrageous in dollar terms until you realize that a car loan is roughly 1/3 this amount and a mortgage is around 1/6.
Here are some suggestions for people who carry a balance:
Buy Down your Rate
The credit card business reminds me a little of the cell phone business - both are ultra competitive and both have launched a mind-blowing number of products and features over the last few years to entice new customers. If any more than 1 year has passed since you first applied for your card, chances are that your provider has new features available for purchase. Some of these features include airmiles, cash back and/or rate buy downs.
Depending on your credit score, you can pay a small annual fee to lower your rate. The following chart shows the extra ANNUAL interest that you are paying for every $1,000 in month end balance to stay with a no-fee card:
If the price to buy down your interest rate is less than the amount shown, you should investigate this option immediately. Remember that the numbers above are per thousand - if you are carrying a $5,000 balance and are going from 28.9% to 12.9%, you need to multiply the $160 by 5 to calculate your interest differential. In this case, you will save $800/yr by dropping to the lower tier. A typical fee to buy down the rate is $30-$75; therefore, this is something that would make financial sense.
Switch to a Different Credit Card Provider
As mentioned above, the credit card business is extremely competitive. For people with decent credit and don't mind the hastle of switching, several credit card companies allow you to transfer your balance and pay a reduced rate for a specified period of time. For example, Bank of America will charge you 3% of your balance to transfer your business, but not charge you any interest for 15 months. For every $1,000 transferred to this program, you would save between $159 (if your current card is at 18.9%) and $259 (if your rate is 28.9%). The downside is that after 15 months, you could well end up in the same situation of having your rate increase and need to find another card.
If you are constantly making the minimum payments on your credit card and not feeling like you are moving ahead, a consolidation loan may be worth considering. Your Bank or Credit Union will normally give a better rate on unsecured loans than your credit card company (if the amount is over $5,000), and will certainly be able to give you a better rate if you are providing some form of security (vehicle less than 4 model years old, second mortgage, assignment of stocks, etc).
Every institution is a little different in terms of their qualification requirements, but in general:
- your total debt load (car loans, credit card/line of credit minimum payments, mortgage or rent costs) together with the consolidation loan payment can not exceed 40% of your total income; and
- your credit score has to be decent.
Other Tips for Wise Credit Card Usage
Once you have gone to the trouble of lowering your rate (or getting a consolidation loan), your best case scenario is to use the money that you would have been paying in higher interest costs to permanently pay down your balance. Here are some other tips to help keep your credit card spending under control:
- Know the outstanding balance on your card. Not knowing the balance can be extremely stressful and will eventually lead to hitting the limit.
- Make good purchase decisions with your card and know the difference between something you WANT versus something you NEED.