Not long after the eggnog wears off, the realisation sets in that you got into the holiday shopping spirit a little too much this season.
Now you’re staring at a credit card bill the size of Santa’s belly.
What’s the best way to get out of the Christmas red?
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You could forgo little luxuries, such as paring down to basic cable and bagging lunch instead of dining out, and direct the extra cash to trim down the debt.
You could also pay more than the minimum payment each month, and attack the credit card balance with the highest interest rate first. After several months of sacrifice, the credit card debt would be conquered, and life would resume as before.
But just like losing weight, there are shortcuts you don’t want to take to pay off holiday credit card debt. Bankrate outlines six of them.
This story was originally published by Bankrate.
If you want to get out of credit card debt, paying the minimum each month is the slowest way to get there. It's also incredibly expensive.
For example, say you have $5,000 in debt on one credit card. Your interest rate is 15 per cent, and your minimum payment is calculated by adding interest to 1 per cent of the balance. So if you pay the $112.50 minimum required each month, it will take 266 months, more than 22 years, to pay it off. And you'll end up paying $5,729.21 in interest on top of the original balance.
The Credit Card Accountability, Responsibility and Disclosure Act of 2009, or Credit CARD Act, makes the consequences of just paying the minimum each month a little more obvious. 'The credit card bill must include a chart that shows if you only pay the minimum, it will take X number of years, and you will pay X amount of dollars,' says Mary Ellen Nicol, a counselor at the nonprofit credit counseling organisation CredAbility in Atlanta. 'It's a good place to start.'
'Do not go into retirement savings for credit card debt,' says Nicol. 'It's too expensive.'
Besides raiding your future financial security, Nicol points out you could owe taxes to the Internal Revenue Service if you withdraw tax-deferred money from certain retirement accounts. Additionally, you may incur penalties of up to 25 per cent if you take out funds too early.
Instead, consider temporarily stopping contributions to your retirement account and use that extra money to pay off your credit card, says John Ulzheimer, president of consumer education at SmartCredit.com. The interest you're paying each month as balances roll from one month to the next is outpacing the returns you're earning from your monthly contributions, he explains. Just remember to restart your contributions as soon as you clear your credit card debt.
Remember that rainy-day fund? Maybe it's time put that cash to use -- or not.
'Losing your job is an emergency. Paying off your credit card is not,' says Ulzheimer. 'It's a financial burden to carry debt.'
Draining your emergency fund to get out of credit card debt only exposes you and your family if a real emergency strikes. You could be vulnerable for a year or longer as you replenish the savings. What constitutes a real emergency? A medical issue, a natural disaster or a job loss, especially with unemployment lasting longer these days, says Nicol.
Ulzheimer says if you feel compelled to use those funds, don't wipe them out. Use a small portion along with other available cash as a stopgap for your credit card debt.
There's some debate as to whether pulling equity out of your house to pay off credit card debt is a good idea. Ulzheimer points out that many homeowners have traditionally tapped home equity to help pay for other debt such as credit cards. However, many homeowners may not even have that option because home prices have fallen too much.
More than 1 in 5 homeowners with a mortgage owe more than their home is worth, according to a third-quarter report on negative equity from CoreLogic, a provider of property information and analytics. Another 23 per cent owe at least 80 per cent of their home's value, which may make qualifying for a line of credit a bit harder and riskier.
'Put a check in the 'careful' column,' says Ulzheimer. 'If you have equity, you don't want to push yourself too close to 100 per cent loan-to-value. You're endangering your home.'
Nicol agrees taking out home equity is a dangerous move, especially since housing prices have yet to stabilise in many markets. The equity that remains in your house is your buffer against default and foreclosure.
'I wouldn't even use it pay off a second mortgage,' says Nicol.
In a similar fashion, paying the credit card bill instead of the mortgage payment is also a huge gamble and a big no-no, says Nicol.
'That opens the door to foreclosure,' she says.
Sadly, this strategy has become much more common in the last several years. An unprecedented drop in home prices has put more homeowners on the brink of losing their homes, says Barrett Burns, president and CEO of VantageScore Solutions, the company behind the credit-scoring model VantageScore.
Also, many families are depending on credit cards as lifelines to buy the basics, Burns says. Therefore, it's important to them to keep those credit lines open, even if it means putting the house at risk.
Credit card issuers are quick to shut down delinquent credit lines because they are unsecured debt. The road to foreclosure, by contrast, is much longer, and many homeowners realise they could have as long as a year before they are evicted. Still, a house is most Americans' largest asset, and jeopardizing it to save a credit card could come back to haunt you.
Avoid payday loans at all costs, says Ulzheimer. Nicol also says title loans, or loans against a car, are usually too expensive to pay for holiday shopping.
However, both recommend considering a signature loan, or unsecured personal loan, from a bank or credit union.
You'll want to make sure you can qualify for this type of loan at a reasonable rate and an affordable minimum payment. Sometimes the rate is better than a credit card; sometimes it's not. And be ready to provide proof that you have the income to pay back the loan.
The drawback? These loans typically come in small amounts, from $5,000 to $15,000, says Ulzheimer. So, if your credit card debt is huge, a signature loan may not cover it all.