Best ways to deal with a credit card debt

Credit card debt

Paying on plastic can be a useful way to free up cash, particularly over Christmas and the holiday season.

However, many Australians will have to pay off credit card debt from the festive season well into 2018. It’s scarily easy to overspend on credit cards and it can be incredibly overwhelming to get on top of credit card debt once you’re in it.

We asked Sally McMullen, resident credit card expert for finder.com.au to explain some of the best ways to get your debt under control cheaper and faster.

Why is it so easy to overextend yourself?

If you’re stuck with post-Christmas credit card debt, you’re not alone. Finder’s analysis of Reserve Bank of Australia (RBA) data shows Aussies borrowed a combined $29 billion on their credit cards in December 2017. That averages out to $1,727 in purchases per credit card. Based on the average 55-day interest-free period, it’s predicted that the interest alone will cost Aussies $230 million.

As well as Christmas, post-Christmas and New Year sales tempt you into spending. Many Australians also travel over the summer period, you may find your finances under extra strain thanks to holiday costs.

If you’re in this position, it may be time to review your credit card statement and transaction history. Understanding where you’ve overspent will help you build a budget to keep your finances under control. When you know why you may have fallen into debt, there are ways you can get out of it.

What are the top 3 actions people should take to get their debt under control?

1. Create a repayment plan

To battle your credit card debt, first create a plan of attack. Consider how much debt you have and set yourself a goal date to have your debt cleared by. The date will vary depending on your debt consolidation goals, the size of your debt and your ability to repay.

Finder’s analysis of the RBA data (mentioned above) 4 out of 5 card holders (81%) plan to pay off their debt in 3 months or less. The remaining 19% will take longer than 3 months to service their debt, with 5% planning to take a year or more to clear their balance. The longer you take to pay off your debt, the more interest you’re likely to accrue.

Let’s say you have a credit card with $2,000 worth of debt collecting 13.24% p.a. interest. If you pay $500 each month, it will take 5 months to clear the debt, and you’ll pay $57 in interest. However, if you only pay $200 each month, it’ll take 11 months to pay off the debt and you’ll pay an additional $131 in interest.

Use MoneySmart’s credit card repayment calculator to see how long it will take to repay your debt and how much interest you’ll pay based on how much you can afford to repay each month.

2. Pay more than the minimum

Usually, you will only be required to pay the minimum repayment amount each month, which is normally only 2-3% of your overall balance. That leaves the remainder of your debt to collect and grow with interest.

While it’s best to pay your balance in full each month, at the very least you should pay as much as you can. Let’s say you have the average post-Christmas credit card debt of $1,727 and you only pay the minimum repayment amount of 2%. It would take 22 years and 4 months to repay the debt and you’d pay $6,471 overall. However, if you paid $180 each month, it would take 11 months to clear the debt and you’d only pay $1,856 overall. This means you could save $4,606 just by paying more each month.

3. Consider a 0% balance transfer credit card

If you want to avoid interest payments altogether, you might be better off with a credit card that offers 0% interest on balance transfers. A 0% balance transfer allows you to move debt to a new credit card with an interest-free offer. You could repay the debt without paying any interest for a certain period of time. The length of balance transfer promotion offers will vary depending on the card, but they usually range between 12 and 30 months.

If you’re struggling to repay multiple debts a balance transfer credit card can make it easier to stay on top of your debts under one account. You can save a whole heap on interest costs with the 0% balance transfer offer.

What are the risk involved with 0% balance transfers cards?

Balance transfer credit cards can be a great way to consolidate and clear debt but they can be risky. If you fail to pay off your debt by the end of the promotional period, your balance will start to collect a much higher interest rate. Unless you make a repayment plan and clear all debt before the interest applies, you could fall into the same debt traps again.

Balance transfer credit cards often come with an annual fee and a balance transfer fee (a one-time fee that’s usually 1-3% of your total balance). Before you apply, make sure the costs of the card don’t offset your interest savings.

You may have to meet strict eligibility criteria to have your balance transfer request approved. Some of these requirements include transfer limits (how much debt you can move), eligible banks (you can’t transfer to a new account with the same bank) and a minimum annual income.

It’s worth remembering if you apply for a balance transfer and you’re rejected it could affect your credit rating.

What are some common mistakes people make when trying to pay off their credit card?

As well as only making the minimum monthly repayment and failing to repay the entire debt during the promotional interest-free period, a common mistake is using your credit card to make purchases while repaying a debt.

If you have a card that charges 0% interest on balance transfers, it’s likely the card will have a higher standard purchase rate. Banks are obligated to direct monthly payments to the debt that is accruing the highest interest rate first. If you use your card to make a purchase, repayments will go towards paying that off rather than the debt that you should be concentrating on.

If you need to make emergency purchases with your credit card, aim to pay extra that month to both stick to your balance transfer repayment plan and pay off the purchase debt before the end of the statement period.

How do you choose a card?

Not every Australian credit card holder is the same, you’ll need to choose your debt consolidation strategy based on your financial situation and your ability to repay. Shop around to find a card that best suits your situation. If you do consider a 0% interest balance transfer credit card, make sure to compare your options before you apply to find the right card for you.

Sally McMullen is an editor at finder.com.au, she is a credit cards, frequent flyer and travel money expert by day and music maven by night.

 

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