This comes up almost every holiday. Because so many of us fail to budget our holiday shopping and spend ourselves into debt oblivion.
Last time I discussed this topic, I took issue with a fellow blogger. Today, it’s with Michelle Singletary, a syndicated columnist (but a Washington Post columnist first.)
She suggested that you terminate using your cards, now that you found yourself up to your neck in debt. I can understand that philosophy- and it probably should be followed by many of us- perhaps forever.
But, if we really are able to develop and follow a budget, using our credit cards REASONABLY may enable us to pay our debt down faster. This really works when we are paid monthly. If we are paid more frequently, I totally agree that we must stop using our credit cards.
(If we are paid monthly, we have not only a budgeting issue, but a cash flow issue. We have bills due on the first, the middle, and the end of the month. By using our credit card- the one that has ZERO debt on its roster- means we don’t increase our interest bills and can husband our cash for emergencies- and still pay down our debt.)
Here’s the part of Michelle’s advice with which I take great umbrage- AGAIN!
As I said last year in a similar context, this is a TERRIBLE plan. I understand the concept of eradicating a debt soonest, to bolster one’s belief that progress is being made… but, electing to pay the debt with the lowest balance first- regardless of the interest rates being charged on all the different balances means many more months of debt and many more dollars spent to get out of our hole.
Instead of dealing with this issue in generalities, let’s get specific. So we really can see how much money is involved.
The first problem is that credit cards (and other vendors) have different methods of computing minimum payments. The choices are the percentage method or the percentage+interest+fees method.
The percentage method chooses something between 1% and 3% of our total balance as a minimum payment. A 3% minimum payment assures that we will pay the balance due in 33.3 years- if we don’t use the card further- and have no additional interest charges. So, really that means we will pay down the debt in closer to 40 years.
The percentage-interest-fees method means we will pay that same (range of) total balance due, plus the interest that was charged this month, plus any fees (annual fees, late payments, etc.) In this case, assuming we charge nothing new on the cards, you will pay more than minimum payment above (since we are paying the current monthly interest); the balance gets paid in about 33 years (dependent upon the interest rate charged) under this program- if we only pay the minimum payment.
I am sure you can immediately see the problem with minimum payments. We will never get out of debt if all we pay are the minimum payments.
The next thing you recognize is that you need to pay MORE than the minimum payment. (I am suggesting that you do so only for the debt that is subject to the highest interest rates.) We should also consider using any income tax refunds one gets to lower this principal debt.
Yes, it’s true, that using my method we may not see an entire bill disappear quickly. But, think of this trade-off. Would you rather see that $ 1000 bill be paid off in 4 months, or paying off the $ 5000 bill first, which takes 16 months- but that also means you saved at least $ 250 over the 18 months (which is when you would have also paid off the lower debt- 1 whole month quicker than was possible under than Michelle’s plan.)
But, many of us really DO need the reassurance of which Michelle spoke. So, we need to do to post a graph of our debt balance each month. In so doing, we will see – graphically- how our debt is being attenuated.
And, we all will be suitably motivated to keep paying down our debt.
And, living without so much stress. And, still not pay outrageous amounts on that debt.
well said!
Thanks, Jessica!
Not living within our means can become such a debt spiral. I’m so glad my parents taught me how to budget, save and stay out of debt at a young age.
Bingo! But, if someone dug the hole, this is the way to get out, Jyll!
True True!!
Thanks, thanks!
A hard lesson for people to learn.. but a much needed one for most!
KemKem-
As long as one can learn from it- and have a viable solution- there are worse dispositions.
The graph idea is brilliant!
Right now, we have a debt on which we won’t be charged interest until October. It’s also our smallest, and we could theoretically pay two thirds of it right now. Obviously, that course makes no logical sense whatsoever. But while I’m a logically driven person, my family is finally in a position where we are digging ourselves out of the hole and towards financial independence. The instant gratification of “completing the step” of clearing a debt is TEMPTING.
Of course, instant gratification (and unforeseen life stuff) is how we got in the hole in the first place… Hopefully, a visual aid will help me frame debt repayment as a series of small incremental steps rather than these huge all-or-nothing goals.
So, Daria, here’s my suggestion for you.
I would accumulate 1/8 of the amount of that interest-free debt each month and either pay it- or put it in an interest-bearing account. So, that when the bill comes due, it can be paid in full and you will save the high rate of interest it will undoubtedly impose (and retroactively, to boot, I’m sure). And, pay down the highest rate debt you have as quickly as you can, keeping all other payments to the minimum.
Looking for those plot lines to cross the y ordinate quickly!
This is a very interesting perspective. We paid off all of our debt a few year ago following the lowest balance method. I wonder now how much extra we paid in interest. Debt free feels great!
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I am thrilled you are debt free. And, don’t look up how much extra in interest you paid- there’s no need to reduce the aura of being debt-free!
Budgeting is the key – and if we can, not going into debt in the first place. I appreciate how you demonstrated your plan using the graph – it makes sense.
Thanks, Lori. I agree with you wholeheartedly.
What another commenter said seems important, to live within our means. I handled my credit card the way she suggested for exactly the reason she suggested. Paying the smaller amounts first and getting those cards to zero *felt* so rewarding, and then, I had only one or two left, and it was easier to wait. But I totally see your point, too, about the interest and saving in the long run.
Living within one’s means is a lofty goal. But, what happens when the family is hit by that emergency- the one for which they lack the cash- and run up their bills. My method will help them get out quicker and easier.
I do use credit cards but pay the balance when the statement arrives. I haven’t ever paid interest and non of our cards have annual fees. Saving money is my best friend.
Me, too, Martha. That’s why the credit card companies hate us 🙂 .
Instant gratification is what so many people want, which I think is why the “pay the lowest balance” philosophy appeals to so many-despite the lack of logic. And maybe it can get people started on that path. Perhaps, in that way and only that way, it is “better than nothing”. Except that people in that debt trap need more than “better than nothing”.
Somehow, settling for instant gratification while folks pay 20, 30, or 60% more on a debt (and, therefore, may never escape from their condition) means that a little extra work- plotting the change to see the better results is the only way to go, Alana.