Summer 2008
Paige learned more in college than what was taught in her academic courses. She would pay her bills by writing checks from her checking account but then discovered that many companies accept credit cards as a form of payment.
Authorizing automatic credit card payments eliminated the mad last-minute rush to bill-paying centers and, of course, it didn't matter how much money was in her bank account. This way, she was sure her utility and cell phone bills would be paid on time. She also found payment of other bills was made even easier because her credit card companies mailed her blank convenience checks.
When Paige graduated and entered the working world, she continued to juggle bills and credit card debt. She started paying one credit card with the convenience checks issued by another. She didn't expect to need to do this forever but, as a recent graduate, she was just starting out and her salary was low. She was confident that with time, as she earned raises and gained work experience, things would be different.
Paige never analyzed her credit card statements closely enough to realize how the habits she had developed were creating significant debt. In fact, she barely looked at anything other than the minimum payment due - because that was the only amount she would pay. She had no idea of the cost of credit or how long it would take to pay off a balance if she paid only the minimum. Because she had fallen into the minimum-payment habit, she ended up paying much more in total interest over time.
As Paige's balances grew - along with her stack of bills - she found that opening her statements was becoming painful. Eventually, the day arrived when Paige had maxed out her credit cards and couldn't obtain any more credit, even though she had filled out numerous applications. When she requested a copy of her credit report to find out why she had been turned down, she was dismayed to discover the true extent of her debt. There she was confronted with how many accounts she had and how much total debt she owed.
Learning to use credit appropriately is an educational process. You should familiarize yourself with where the danger line is - and when you have crossed it. To calculate your debt-to-income ratio, divide your total monthly debt payments (including your mortgage and car payments, if you have these) by your monthly gross income.
If you find yourself overextended, the following steps can help you work your way out of debt.
- Cease using your credit cards. Put them away in a safe place where you won't be tempted to use them.
- Although it may be a painful exercise, calculate the true extent of your debt. Make a list of these amounts and add them up.
- On your list, record the minimum payment. Starting now, try to pay more than this number. Paying even a small amount over the minimum reduces both the amount of interest paid on your debt and the time it will take to pay it off.
- Make a priority list for paying off your cards. Some people prefer to start with the lowest total-balance card. This helps you feel a sense of accomplishment by paying off a card. Others prefer to start with the highest-interest-rate card. This costs less money in the long run since you will be dealing first with the cards holding the higher interest rates.
- Get into the habit of mailing your payment upon receipt of the bill. Some credit cards accumulate interest charges every extra day you delay, if you carry a balance from one month to another. Even if your cards don't calculate interest in this fashion, it's good to pay immediately, before that money gets detoured into other expenses.
- Consider consolidation of high-rate credit cards by moving these balances to a card with a better interest rate. However, resist the temptation to continue to use these now "empty" cards.
- Resolve to be a credit-wise user once you've cleared up your balances. Don't fall into the same pattern that got you into trouble in the first place.
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Dara Duguay is Director of the Office of Financial Education for Citi and the author of several self-help personal finance books.