5 Sobering Facts About Credit Card Debt
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Credit cards can be very convenient. With minimal effort, you can access a sizable amount of credit to buy anything you wish. Plus, they enable you to handle almost any expense that pops up, even costly ones such as vehicle repairs, urgent home maintenance, or medical emergencies.
So, what's the problem with credit cards? Here are five seriously sobering facts to consider.
1. Credit Card Balances Have Grown Explosively
Reliance on credit card debt has grown dramatically in recent decades. In 1976, the total of all revolving debt was around $14 billion dollars, according the Federal Reserve. Over the next few decades, the total climbed to $135 billion in 1986, $450 billion in 1996, $900 billion in 2006, and now stands at nearly one trillion dollars.
The huge and growing amount of credit card debit results in millions of people paying billions of dollars on high interest credit card bills, instead of saving and investing for a financially secure future. This has a broader economic impact — servicing interest payments is a relatively useless economic activity, unlike making actual purchases or investing. If interest rates rise significantly from current historic lows, millions of people could be unable to keep up with their credit payments, resulting in economic chaos.
2. Credit Card Minimum Payments Make You Poor
If you've received a credit card bill, you know that it presents a minimum payment due. Of course you can send in more than the minimum to pay off your balance faster, but many people don't. This results in longer debt servicing and paying significantly more interest to the credit card company.
Let's say you have a balance of $5,000 on a credit card account with an interest rate of 18.9%. If you make minimum payments of 4% of the balance, it will take over 11 years and cost over $8,000 to pay off this credit card. If you paid 7% instead of the minimum payment, it would take six years and cost $6,420 to pay off this balance. Paying more than the minimum adds up to significant savings: over $1,500 and five years of difference in this example.
If you make only the minimum payment, you could end up making payments on the same credit card for well over a decade!
3. Ridiculous Interest Rates on Credit Cards
According to data from the Federal Reserve, the interest rate on the average credit card that assesses interest is 13.70%. Credit card rates can go upwards of 23%, or higher in some cases (for those with bad credit or miss payments resulting in a "penalty APR").
By way of comparison, the current average interest rate on a savings account is 0.06%. This means that you are paying over 200 times more interest on credit card accounts than you receive on a savings account. Credit cards are a very expensive way to borrow money!
4. So Many People Rely on Credit Cards
About 38% of American households carry a credit card balance. This works out to around 45 million households in the richest country on earth. Why do so many people rely on credit card debt when credit card interest is ridiculously high?
The reason is simple — people are living above their means. Credit card financing allows people to buy things they couldn't otherwise afford, but this comes at a high price both in terms of interest payments and in terms of missed opportunities for saving and investing.
5. Credit Card Utilization by Older Consumers
I expected that young people would have the highest credit card utilization, with credit balances decreasing as their income increases and they approach retirement age. This turns out to be the opposite of the current trend.
According to surveys by Value Penguin, Millennials (age 18 to 29) and people over 74 have the least credit card debt, with those in the middle age groups having the highest — an average balance of over $8,000. A Bankrate survey found that only 35% of adults over age 30 don't have credit cards, but this rises to 63% among Millennials.
The fact that Millennials are not racking up a lot of credit card debt is encouraging for our economic future. But the fact that those from middle-aged through age 64 have billions of dollars in credit card balances could be a financial crisis in the making. If people do not have enough income at the prime of their careers to avoid credit card borrowing or pay off credit card debt, what is going to happen when they stop working and have much less income?
What to Do About Credit Card Debt?
High levels of credit card debt are an impediment against personal financial stability and a risk to the stability of the overall economy. The more money people spend making debt and interest payments, the less money they have available to build an emergency fund, savings, and investment for the future.
But if you do have credit card debt, here are some common-sense tips to help pay off your balance faster:
1. Analyze Your Budget
If your credit card balances are growing, work out a detailed budget to understand how much you have coming in and how much you can afford to spend. Cut unnecessary spending, try to pick up some extra income, and work to exceed the minimum payment amounts to get those balances paid off as soon as possible.
2. Keep Your Credit Rating High
Make payments on time and keep some unused credit available on several accounts. Avoid maxing out all of your cards. A good credit rating will give you options to refinance debt at a lower cost.
3. Find Lower-Cost Loans
You might be able to finance your debt at a lower interest rate using a vehicle other than a credit card. See if you can get a home equity loan or credit card consolidation loan through your bank or credit union. You might be able to reduce your interest rate by 50% or more.
4. Take Advantage of Balance Transfer Offers
You may be able to transfer your balance from a high interest rate credit card to one with a much lower interest rate. I commonly see balance transfer offers for 0% interest, but you may have to pay a transfer fee of 3%. Still, this is much better than paying 16% on a balance. Use your time with 0% to pay down your balance as much as possible.
5. Use Cash Instead of Credit Cards
I use a money envelope instead of credit cards to buy food. It is more painful to spend cash, so I spend less. Plus, I stop spending when the cash is gone, so I never exceed my budget.
What are you doing to to control your credit card usage?