This is a guest post from Phil Taylor, creator of PT Money: Personal Finance.
It seems American’s are trying to get out of credit card debt. According to TransUnion, the average combined credit card debt for bank-issued cards fell by 13% for the three months ended June 30th, 2010 when compared to the same period last year. The average debt is now just $4,951. I’m happy to see these improvements, but I know some of those consumers are still a long way from being debt free. And while the road to debt freedom is paved with good intentions, it’s also littered with potholes. I should know. I racked up a bunch of credit card debt in college and spent several working years after trying to get rid of it.
Getting out of debt can take a long time. And any long-term plan is going to be affected by life’s little ups and downs. But there are some mistakes you can avoid if you know what to look for.
Here are some common mistakes that people make on their way out of debt.
- Taking a Short Cut – If you believed all the advertisements you see and hear each day, you would start to believe that your debt isn’t your responsibility. And that there are many people, even President Obama, who want to bail you out. Don’t believe the hype. There are no magical plans to help you eliminate your excessive credit card debt that won’t either cost you more than you should pay, or end up negatively affecting your credit score. Get out of debt the old fashioned way: stop using credit, list out all your debts, and pay them off as fast as you can with your extra money.
- Changing the Form of the Debt – Another big mistake that people make with their debt is to transform the form of the debt. A perfect example is using a home equity loan to pay off your credit cards. By doing this you are transferring the risk of your debt from an unsecured place, to an asset of yours. You are effectively putting your home as risk because of your credit card spending. Your home has nothing to do with your credit card problems. Don’t get them mixed up.
- Obsessing Over Which Card to Pay Off First – The classic debate amongst the financially literate types is whether to use a “debt snowball” approach or a “debt avalanche” approach. The first approach says that psychology is most important and that you should pay your smallest debts first. The second let’s math trump everything and says you should pay off the card with the highest interest rate first. I say pick which method works for you and get to work. Don’t get bogged down into which method is best. The one that is working for you is best.
- Not Having a Plan – I stated above that you shouldn’t be obsessed with the plan. But I didn’t say you should go without a plan. A simple, prioritized list of all your credit cards, payments, interest rates, balances, etc. will do. Make sure you check your credit report to ensure that you are actually dealing with the complete list of all your debts.
- Not Creating Additional Income – By bringing in a second source of income, even if temporary, you will be taking months off of the time it takes to complete your debt reduction plan. Extra funds can come from several places: selling your old stuff, starting a small business, or simply taking on a part-time job. People who skip this step aren’t putting their best foot forward.
- Not Reducing Expenses – A huge mistake that some make is not changing their spending. You are likely in debt because your spending has been exceeding your income. You need to put an end to this. Reduce your spending using a budget and put those credit cards in a place where you won’t be tempted to use them again.
- Poor Execution of a Balance Transfer – It can be tempting to use a promotional balance transfer credit card offer to help you shift your debts to a card with no interest. This is a great strategy as long as you follow the credit card company’s rules, and as long as you don’t tack on more debt on top of your transferred balances. Even if you think you’ve found the best 0% balance transfer credit card, you can still get tripped up if you miss a minimum payment, or if you let the promotional period expire before paying off the card.
- Senselessly Closing Old Accounts – Finally, as you pay off your credit cards, you may be tempted to cut up the cards and close the account. Cutting up the card isn’t the worst idea (they can always ship you another). But closing your account may be a bit extreme. Plus, it will have a negative affect on your credit score by reducing the amount of available credit that you have.
What are some tips that you have for not getting tripped up on your way out of credit card debt?
RJ’s Note: Thanks Phil, for taking the time to write this post. Personally, I was fortunate enough never to have much debt. Therefore, it’s hard for me to relate sometimes to those in that situation.