The 9 Steps to Financial Freedom (30 page)

This is where these companies can get you big-time. Even if your introductory rate is zero percent, if you take out a cash advance, regardless of whether or not you owe a balance, many companies charge a fee of as much as 4 percent of the amount of each cash advance. And there is no grace period with the cash
advance; you start paying interest immediately. By the way, even if you have a zero percent interest rate, you are going to get hit with a different rate on the cash advance. It typically is more than 20 percent. Some cards will charge you less for cash advances or tell you to use the convenience checks they supply, but you have to ask, because many companies charge those exorbitantly high interest rates even when you use their convenience checks. “Convenient” for them.

Is There an Annual Fee?

The best cards will not charge a fee, or just a small charge of less than $20.

Then there are the essential questions: What is the current interest rate? How long will this rate last? What does the interest rate go up to after the introductory period?

Again, you need to scrutinize all offers carefully—sometimes the rates for balance transfers and cash advances are higher. And their introductory rate may jump by 20 percentage points or more after a few months. Obviously you want the card with the lowest introductory rate, and the longer the low rate lasts, the better. In any case, you don’t want a card whose normal rate is above 10 percent.

Take a look at the table that follows and you will see how much more you will pay and how much longer you will pay with higher interest rates. If you have an $8,000 credit card balance and are paying a monthly minimum of $320:

First thing: Put all your credit cards away in a drawer so you will not be tempted to frequently use the cards. If you know you won’t be able to control your spending, then cutting up your cards may be the best move for you. But ideally what I want you to do is keep your cards but not use them more than once a month for a small purchase. If you don’t use the credit card at all, the card company may cancel your account (not the debt you already owe; they will just cut off future purchases). That can have a negative impact on your FICO credit score. When an account is closed down your overall available credit limit will drop, and as I explained earlier, your debt-to-overall credit limit is a major factor in your credit score. So that’s why it is best to keep an account open. But be honest with yourself here. If you know you will be unable to curb your overspending, then you need to consider cutting up the cards completely. If the card issuer ends up canceling your card, that’s the price you will have to pay for gaining control over your overspending.

Now is the time to sit down with your debt, study your statements, face what you owe, and see what they’re charging you to owe it.

Make a list of all the money you owe in descending order, starting with the highest interest charges first. List as well the phone number of everyone you owe money to. Please include personal debt. Debt is debt, and just because most personal debt doesn’t inspire the fear of most corporate debt, on the scale of self-respect it weighs in pound for pound. List the amount you owe, the interest rate, and the minimum monthly payment. For example:

If you’re late with any of these payments, personal or institutional, call them up now and tell them why. All the entities to whom you owe money already know that you don’t have the money to pay the bill or you would have, so don’t be embarrassed. With your new truth from Step 3 in hand, pick up the phone and call. You’re in debt, that’s all. You’re not a failure or a bad person. If someone is rude to you, be very kind and gentle in return. Explain your situation. It might be that you’re late but will have the money in two weeks. Or it might be that you can only send them $25. In any case, call them before they call you.

If you’re not late with your payments, call up the high-interest credit card companies anyway, tell them you’re considering switching to a better value card, and see if they’ll match a lower rate. You can negotiate with them, and often they will reduce your interest rate right on the spot. If they won’t make good on your request, try to move the balance to a card that meets the criteria just discussed. If what they will agree to is not as good a deal as you can get elsewhere, you’re out of there.

Offers keep changing from company to company, so keep up-to-date on the best offers by checking a current issue of
Smart Money
magazine (
http://www.smartmoney.com
) or
Kiplinger’s
magazine (
http://www.kiplinger.com
). You can also check via the Internet site
www.creditcards.com
.

If you have a blemish on your credit record, try to clean that up before you start switching companies. Credit card companies don’t like it even if you’ve been just one payment late, and for that reason alone a better company could turn you down.

If you’re in big credit card trouble, don’t panic. But you can get out of it, a step—or a month—at a time. I have found that most people are not aware of how very important it is to pay more than the minimum. Let’s say you owe an average balance of $1,100 on a card that charges 18 percent interest. If you pay the minimum 4 percent every month, and you never charge another thing, it will take you about seven and a half years to pay off your debt. It will have cost you $576 in interest.

Same situation, but if instead you had paid $10 more than the minimum each month, you would have cut the payment period down to two years and your interest payments would be just $218. That is a savings of $358. Ten dollars a month is only thirty-five cents a day.

Remember, with many cards, the more you owe the longer it will take you. I have seen cases where just paying the minimum every month would mean that the debt would take forty years to pay off, to say nothing of the thousands and thousands in interest it would cost you.

Let’s assume that you owe $4,000 and see what a difference a few bucks will make at different interest rates. Once I showed my clients this chart, they began to see what a difference a little more money each month can really make.

These are the steps that many people, including quite a number of my former clients, have taken to get out of debt. You can do it, too.

1. Figure out the absolute largest amount you can afford to pay monthly toward your credit cards. Let’s say that amount is $600 a month. You may think this is a lot, but when you carry a lot of debt on at least several different cards, this is probably not much less than what all your payments add up to.

2. Review the list of creditors you owe money to and total the cost of the minimum monthly payments,
plus $10
, for each of them. If the minimum payment on one card is $150, write down $160, and so on; then take the total of those figures.

3. Subtract this total from the number you wrote down in step 1. Let’s say the minimum payment plus $10 for all of your credit cards is $400. You’ve decided that in fact you can pay $600 a month toward eradicating the debt. Subtract the $400 you must pay from the $600 you can pay, and this leaves you with $200 extra to pay on your credit cards.

4. Now take the “extra” $200 and put it monthly toward the credit card that is charging the highest interest rate. When that card is paid off, put it in a safe place where you won’t
frequently use it, or cut it up. But don’t cancel the account; it will hurt your FICO score to close out the account.

5. Now you start all over. Stick with $600 a month (unless you can raise it!) as your debt-paying allocation. Total all the minimum payments of your remaining cards, adding on $10 to each card. Let’s say that this figure is now $300 a month. Subtract this from the $600 you have allocated a month, leaving $300. Pay that $300 to the card that is now charging you the highest interest rate.

This whole process may take months or it may take years, but with each payment you will be closer to becoming debt free, at which time you’ll be free to pay yourself more and more. Look at the statements each time carefully, keep transferring accounts for the best interest rate deals as necessary, and take pleasure and pride each time the amount due is smaller. With each payment you are that much closer to financial freedom.

You may be able to borrow from yourself to pay off your credit cards through your 401(k) plan at work. Many employers will let you borrow up to 50 percent of the money you have in your plan, up to $50,000, to buy a house or pay off bills or for other situations that qualify. Be careful in doing this, however; the supposed upside is that when you borrow money from a 401(k), you have five years to pay back the money (rather than the forty years it could take you by paying the minimum on some credit cards). In addition, the interest you pay goes right back to yourself—that’s right. It’s your money, you’ve borrowed it from yourself, and you’re paying it back directly into your account;
all the payments plus interest go to you. Usually you will pay yourself about 2 percent above the prime rate, which is the basic interest rate set by the government.

But the realistic downside is this: when you borrow money from your 401(k), you are losing out on the growth potential of the money. So it’s a decision to be made cautiously and wisely.

Another consideration is that if you take out a loan on your 401(k), you are in essence paying back money that you have never paid taxes on with money you have paid taxes on, and then, when you go to take the money out sometime in the future, you will have to pay taxes on it again. That really makes no sense. So you really have to think about this carefully before you take out a loan from a 401(k). Not only are you losing growth on this money, but you are subjecting yourself to double taxation.

Another prospective downside is that if you happen to leave the job or get fired, the money you borrowed is due in one lump sum at that time. If you can’t pay it back, you’ll pay taxes on the money as if it were ordinary income; if you’re under the age of fifty-five, you may also have to pay a 10 percent penalty on the amount you haven’t paid back. If you are thinking of taking out a loan, and there is a possibility you may leave your current employer, you might want to reconsider your situation before you take out the loan; make sure you understand what you would have to do if you were to leave your job.

Another alternative, if you’re really in credit card trouble, is to take out a
home equity loan
to pay off your debt. A home equity loan can have its advantages. The loan may be at a lower interest rate than your credit card, and often that interest is
tax-deductible, so you’ll have converted a high-interest, non-tax-deductible debt to one that has lower interest and is probably tax-deductible.