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Dealing With Credit Card Debt: How to Get Debt-Free

By: Motley Fool
Posted: 9/7/2013 10:30:00 AM
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If you struggle with credit card debt, you're not alone -- the average American credit card balance is more than $15,000. But there are many ways you can reduce your debt without harming your credit score, and with a solid payment plan in hand, you'll be debt-free in no time.

In this article:

Understanding credit card debt
The first step in getting rid of your debt is understanding how it's made. Every month, you make your purchases. At the end of the month, you receive your statement asking you to pay for that month's purchases as well as any other debts you haven't paid off. You then have 21 to 25 days (depending on your credit card) to pay off the previous month's debt. If you don't pay it off, you'll be charged interest, and a charge of your APR (annual percentage rate), divided by 12, times your outstanding balance, will be added to the debt you owe. Here's an example.

You have a credit card with a 15% APR, a $35 late fee, and a 25-day grace period. In January, you spend $500.

On Feb. 1, you receive a statement saying:

  1. Your outstanding balance is $500.
  2. Your minimum payment is $25.

From there, you have a few different options. Because your grace period is 25 days, you have until Feb. 26 to do any of these:

If You Pay ... Your Outstanding Balance Will Be: If You Paid This Amount Every Month:
$0

$541.25:

  • $500 in unpaid purchases
  • $6.25 in interest
  • $35 in late fees
You'd probably get a debt collector calling at your door.
$25

$480.94:

  • $475 in unpaid purchases
  • $5.94 in interest
Your $500 in purchases will cost $588, and it'll take you nearly two and a half years to be debt-free.
$250

$253.13:

  • $250 in unpaid purchases
  • $3.13 in interest
Your $500 in purchases will cost $503, and you'll have your debt paid off in three months. Note that it takes longer to pay off $500 than two payments $250 because of interest charges.
$500 $0 You'll have paid off your balance in full, and your $500 in purchases will remain just $500.

The key takeaways here:

There are two ways you can lower your interest charges:

  1. Lower the amount of debt outstanding.
  2. Lower the interest rate.

We'll break down in detail how to do each of those.

Lower the amount of debt outstanding
While there are a couple tricks you can use to pay off your debts more efficiently, and tools you can use to make it more painless, in the end, cutting down your debt comes down to this: You need to put more money toward getting debt-free. This means:

Allocating more money to getting debt-free is the best way to move the needle; that said, you can also allocate your money more efficiently by paying off your highest-interest debt first (debt snowball aside). Other than that, it's all about putting more in to get more out.

Lower the interest rate
This is where things get a bit interesting. There are a number of ways to reduce your interest rate; you should try the following and stop at the first one that works.

1. Apply for a 0% balance transfer credit card
The easiest way to cut your interest cost is to apply for a new 0% balance transfer credit card. Such cards have an introductory period (usually six to 18 months) where your outstanding balance isn't charged any interest. You can shift your old credit card debt to the new card and have some time to pay it down without accruing interest charges. Credit card companies are eager to steal others' business and are opening their purse strings to debts from other lenders.

Be careful, however, of balance transfer fees. This one-time charge, usually 3%-5% of the transfer, is added to your balance when you shift it over. For example, if you transfer $1,000 to a new credit card with a balance transfer fee of 3%, your outstanding balance at the end of the month will be $10,30.

2. Shift to a lower-rate card with your same bank
Remember that banks are competitive and want you to keep your accounts with them. Try to switch your debts to a lower-rate card at the same bank by threatening (politely, of course) to leave and take your money elsewhere. Alternatively, try to negotiate a lower rate on your existing card.

3. Consider debt consolidation
If you have the credit for it, consider taking out a home equity line of credit or another secured loan to pay off your (unsecured and therefore more expensive) credit card debt. However, keep in mind that if you fall behind on your debts, you can lose your house.

What to do if you're in over your head
When worst comes to worst, you do have a few options:

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