In response to rampant inflation, the Federal Reserve -- the
US' central bank, which is in charge of monetary policy -- has initiated
several interest rate hikes since March. This has a ripple effect through
nearly every part of the economy, including financial tools like credit cards.
Credit card APRs, or interest rates, are increasing in tandem with the Fed's
hikes. Unfortunately, that could cost you a lot of money if you've got credit
card debt.
If you carry a credit card balance beyond its due date,
it'll be subject to the APR determined by your specific credit card and credit
score. For people carrying a balance from month to month, their interest
charges will continue to get more expensive with each rate hike. And you
typically won't get notified if your interest rates increase.
Below we explain how this rate increase will affect your
credit card statements, with examples, along with some steps you can take to
pay down your balance and save money.
Why credit card debt is becoming more expensive
By raising the federal funds rate -- the overnight interest
rate between banks -- a domino effect causes credit card APRs to increase.
Though the federal funds rate only directly dictates lending between banks,
this affects the banks' costs, which are in turn passed on to consumers.
The prime rate, which is the basis for all borrowing rates
for bank customers, is derived from the federal funds rate. Premiums are tacked
onto it depending on an applicant's creditworthiness and institutional factors.
This yields effective interest rates, such as credit card annual percentage
rates.
But when should you expect credit card rates to rise? Credit
card APRs are adjusted almost immediately, usually within a billing cycle or
two. You've probably already been subject to new APRs from previous rate hikes
without even realizing it.
If you pay your credit card bill in full every month, you
have nothing to worry about. But if you have a balance on that card, carrying it
month to month will cost you more once rates increase.
Here's an example. Let's say you carry a credit card balance
of $5,525, which is the national average according to the credit bureau
Experian. Meanwhile, the average new credit card interest rate is roughly 20%.
If you make only a minimum payment (let's assume the minimum payment is the
standard 2%), paying off your card's balance would take you just over 58 years
and cost you more than $24,750 in interest.
However, if credit card interest rates were to increase by
one percentage point, paying off the same balance would take over 76 years and
cost over $34,400 in interest. Do your own math using CNET sister site
Bankrate's credit card minimum payment calculator.
So what should you do right now? Here are six steps you can
take to pay your credit card balance and save money.
1. Pay off, or at least down, any existing credit card
debt
US consumers have done a good job lowering their credit card
debt during the pandemic. As Experian found, the average credit card holder
lowered his or her card balance by almost $400 in 2021 compared with 2020. So
chances are you're already in debt-paying mode. Kudos to you!
The first step to paying off your debt is simple: Apply any
disposable income to credit card debt. (And if you don't have enough disposable
income to begin with, don't panic. I'll get to that in a minute.)
Where to begin? The average US consumer has around three
credit cards, so there's a chance your credit card debt is spread across
multiple balances. There are two popular methods for paying down multiple
balances: the snowball method and the avalanche method.
The snowball method suggests starting by paying off
your smallest debt first, regardless of its interest rate, and letting your
initial success carry you until you pay the debt with the highest balance.
Proponents of this method argue that this strategy allows you to create a
snowball effect, or momentum that encourages you to pay off multiple debts.
The avalanche method, on the other hand, proposes
that you start with the debt with the highest interest rate. Once you've paid
off that high-interest balance, you move on to the balance with the next
highest interest rate, and so on.
Which method is better? Avalanche method fanatics -- and
many personal finance experts -- will tell you that paying off high-interest
debt first makes more sense from the financial standpoint. The faster you pay
debt this way, they say, the more money you'll save in interest over time. But
if paying off that debt will take you years, you may be discouraged by what
seems like minimal progress for maximum effort. You might end up throwing in
the towel and keep accruing debt.
My advice is to go with the method that'll keep you going,
whether it's snowball, avalanche or a combination of both. In the end, what's
important is to save money in interest one way or another.
2. Transfer your balance to a 0% APR credit card
If you have a good credit score, chances are you may be
eligible to apply for a balance transfer credit card. The best balance transfer
cards let you transfer a balance from another card -- as long as it's from a
different bank -- and pay it with no interest for a set period of time, usually
between 12 and 18 months. Some cards in the market are currently offering up to
21 months.
Make sure to consider fees when shopping for a balance
transfer card. Most cards charge a balance transfer fee, usually 3% of the
amount transferred, though some cards charge no balance transfer fees.
Next, use CNET sister site Bankrate's Credit Card Balance
Transfer Calculator to estimate how long it'll take you to pay off that balance
based on how much you could pay each month. Then, look for a card with a
similar zero interest promotional period. Remember that once the promotional
period ends, the card's regular APR will kick in, and you'll start paying
interest on any remaining balance on the card. Consider applying for the card
that, combining balance transfer fees and intro period, will allow you to pay
off your balance for less.
3. Focus on paying down card debt, not on earning points
or cash back
Earning cash back, points and miles on everyday purchases
and redeeming them for free trips or the newest smartphone is every savvy
cardholder's dream. But if you're carrying a balance on your credit cards and
keep charging expenses you can't pay at the end of the month for the sake of
earning points, you need to stop immediately.
Here's why. As I mentioned before, the current average
interest rate is above 16%. Some of the best credit cards earn up to 6% back in
rewards per dollar spent on specific categories, like grocery store purchases
or airline tickets. However, most of the best flat-rate cash back cards earn no
more than 2%. Any cash back, points or miles earned will be easily wiped out by
interest if you don't pay for your purchases in full when your statement is
due.
If you carry a balance, there's a way to put those
hard-earned cash-back dollars to good use. Use them to lower the balance on
your card instead by redeeming them for a statement credit.
4. Consider additional sources of income to pay off
credit card debt
But what if you don't have any additional cash at the end of
the day, or the month, to pay down card debt?
That might be the reason you got into debt to begin with --
and that's OK. We've all been there. But adding an extra source of income can
help you tackle any kind of debt faster, including your credit card's.
Here are a few ideas you can try to earn more disposable
income and pay down credit card debt:
Take on a side gig. Are you good at math or fluent in
a foreign language? Tutoring can be a viable option for a side job. Do you have
free time during the week and a car in good condition? You might want to consider
Uber, Lyft or DoorDash. Many successful Etsy stores started as a side hustle.
Consider an activity you enjoy and make sure to follow these tips, as taking on
a side gig might have tax implications.
Rein in your expenses. Duh, I know -- it sounds
obvious, but it's not that simple. According to the Federal Reserve, almost 40%
of Americans don't have $400 in emergency cash. Whether this is your case or
not, maybe it's time to align your expenses with your income, create a budget
and stick to it. The good news is that you can add paying down card debt as one
of your ongoing expenses, and you don't have to create a budget from scratch or
manage it all on your own. The best budgeting apps can help keep track of your
spending and identify expenses to cut back.
Sell stuff you don't use that's just sitting around the
house. From that dress you wore only once at a wedding to the portable
sauna you got for your birthday but never fire up, reselling both used and new
stuff online can help you earn the extra cash you might need to pay off credit
card debt. There are plenty of places to do that. The Penny Hoarder has a good
roundup of 14 websites and apps for selling stuff online.
5. Stop using your credit card and switch to cash or a
debit card
Credit cards are great financial instruments to pay for
large or unexpected purchases over time, improve your credit, earn points or
cash back for trips or dream buys, or even give you access to generous travel
benefits, like airport lounges or priority security access. But they can also
tempt you to overspend and to incur debt fast if you don't manage them
responsibly.
If you find yourself spending more when using a credit card,
maybe it's time to give plastic a break. Studies suggest that paying with a
credit card might lead to overspending because the "pay pain" is
removed from the transaction. In other words, when you charge a purchase on
your credit card, the money doesn't leave your wallet or bank account right
away, which may mislead you into thinking you can afford whatever you're
buying.
Switching to cash might be more difficult than before,
especially since many businesses during the pandemic switched to contactless
payments or stopped accepting cash, for safety reasons.
However, you could use a P2P payment app, like Venmo or
Zelle, or simply your debit card. That way, the moment you make a purchase or
pay a bill, the money gets instantly withdrawn from your bank account, helping
you get a better sense of how much you're spending.
6. Leverage your credit with a zero percent credit card
If you don't carry a balance on your credit card right now,
congratulations! But if you have good credit, you might still want to consider
applying for a no-interest credit card. Even if you pay your balance in full
every month, there may be some benefits in the midst of rising interest rates.
You can pay for a big-ticket purchase interest-free, or have a zero percent
card on hand in case of emergency.
Improving your credit utilization ratio and upping your
number of accounts by opening a new credit card can be beneficial for your
credit score, too. This type of simple move could be really beneficial for you
in the long run, particularly if you plan to finance a home, auto or other big
purchase in the future.
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