What type of debt should you paydown first? Ask your family, a financial planner, a blogger, or even someone off the street, and just about everytime they are going to tell you to pay off those credit cards! Credit cards carry a very negative stigma, and deservedly so. According to creditcards.com, the average credit card balance for all households that carry debt is $14,750. What’s even worse, that balance carries an average interest rate of 13.67%. Considering a minimum monthly payment of 2% of the balance, and it will take you over 50 years to pay it off. Over those 50 years, that $14,750 will cost you over $19,000 in interest. That 13.67% is over 2.5 times my mortgage rate, and more than twice as much as the rate attached to my student loans. Yet despite these eye opening facts, there are still times when it’s NOT prudent to pay down those credit cards first. Bet you didn’t see that coming, huh? I’m going to give you 5 examples of when it’s alright to hold off on paying down those credit cards!
According to Credit Card Guide, in the 4th quarter of 2010, 52% of consumers who defaulted on debt were over 30 days behind on paying their mortgage. Out of this same group of consumers, only 22% were behind on their credit card payments. I’m not saying it’s alright to just shirk your financial responsibilities and allow your credit cards to go into default. On the other hand, if you simply don’t have enough to pay both, then that money would be better spent on your dwelling. Though unlikely, just one month in default can begin the eviction process for a homeowner or renter. Credit card companies may wait months for a payment, they are also more apt to work out a payment plan, and they can’t throw you out on the street!
I have written about the dangers of student loans a few times, and for good reason. Once acquired, these loans are with you for life, at least until you pay them in full. This is one of the few types of debt that cannot be written off during a bankruptcy. If you are falling behind on your payments, or feel that bankruptcy is inevitable, make sure you are allocating your funds wisely. Don’t keep paying that mortgage if you know it’s going into foreclosure. Don’t pay your credit cards if they are in default. Apply those funds to that ball and chain we call student loans.
Another financial obligation that is impossible to shirk, and for good reason, are child support payments. Being a child of divorced parents I was privy to this process first hand. Despite the misfortunte of those who have to file bankruptcy, they will still have to make these payments before, during, and after the proceedings are done. If you have limited available funds, would you rather that money go to credit card companies…or your children? In a perfect world you would meet all your financial obligations, but considering the current state of our economy, we sometimes find ourselves picking and choosing.
The 0% APR cards are back and here to stay! I would never advocate that you carry a balance on your card, but if you already are, then find yourself a 0% APR card. I have a Discover More card with a promotional one year 0% interest rate. Im not a stock guru, but even I can make some safe stock picks that will outpace 0%! Continue to make your minimum monthly payments on your card, but use excess funds to invest in safe dividend paying stock, a one year CD, or even an aggressive money market account. When the balance comes due, use those interest earning funds to pay it all off.
Finding extra money to apply to credit cards can be daunting. I know in the past I tried selling items on ebay/amazon, cashing in change, cutting back on expenses, and even earning income online. Now consider that the average tax refund in 2010 was over $3,000, or $250 per month. For many people an extra $250 a month may put a nice dent in their credit card balances. So why not improve your tax planning skills and use that money where it’s needed? Here’s why…because you won’t! I know, I dont you, and I shouldn’t pretend that I do. However, I do know that personal finance is at least 50% psychological, after all, there is a reason why you got yourself into debt in the first place. If you start receiving that large lump sum annual refund in smaller monthly amounts, you will most likely spend it on things other than paying down your debt. So you gave Uncle Sam an interest free loan, the opportunity cost is minimal. When you receive that large annual refund, you will be more apt to use it on paying down your debt. Seeing $3,000 knocked off your balance is a powerful thing, and it may motivate you to keep the ball rolling.
I hope you paid attention, because you wont see many personal finance enthusiasts giving you reasons NOT to paydown your credit cards. I promise my next topic will be more financially responsible 🙂