Are you knocking off credit card debt the right way?

Are you knocking off credit card debt the right way?

Ultimately there are 2 ways to pay off credit card debts

(i) Pay off your debts in full. This means paying the full interest and principal.

(ii) Pay less than what you owe. This means keeping maximum amount in your pocket and paying the minimum amount to your creditor.

Now there are 4 ways to pay less than what you owe:

  • Debt settlement
  • Debt management
  • Credit card balance transfer method
  • Bankruptcy – Chapter 7 and Chapter 13

Debt settlement brings down your outstanding balance by more than 40%. The figure varies depending on the creditor and the overall amount.

Debt management pulls down the interest rate depending on your affordability.

Bankruptcy brings down your payoff amount through court’s intervention.

Credit card balance transfer method is a smart way of consolidating your debts. Here you can transfer your balance to a 0% interest credit card and pay off the outstanding balance within the introductory rate period. You can skip paying the high interest on your card.

There is yet another logical way to pay off your credit card debt. You pay a set amount on all your credit cards. Dedicate the remaining amount on the credit card with highest interest. It’s the optimal behavior.

The best and the most logical way to pay off credit card debt is to attack the card with the highest APR.

This process seems to be easy and practical right? But most people aren’t knocking off credit card debt in this way.

How are consumers paying off credit card debt?

A recent study on 1.4 million credit card holders having revolving balances revealed a few startling facts. The study was conducted to know how these people are splitting payments between credit cards. Are they splitting payments depending on interest rates or overall balance?

Revelations

  • Debtors are allocating only 51.5% of their extra payments to the credit card with high APR. But the right way to pay off credit card is devote 100% of your extra payments to the highest interest credit card.
  • Only 10% of credit card holders are paying off debts the right way.
  • Debtors are evenly splitting their payments on credit cards irrespective of the interest rate and the number of cards in their hands.
  • Debtors are losing money on interest payments annually. Those who have 2 credit cards are losing $90 every year due to unnecessary interest payments. Those who have 5 credit cards are losing $327 every year for the same reason.
  • Top 10% of debtors with 5 or more credit cards are wasting $1000 every year due to improper allocation of payments.

Psychology behind the illogical consumer behavior

Some financial experts suggest debtors to pay off their smallest balances first for easy wins and motivation. But credit card holders are not doing that. What is the psychology behind it?

If you study all the payment models minutely, then you’ll realize that ‘balance-matching’ model describes the card holder’s peculiar behavior perfectly. In the ‘balance-matching model’,

“individuals match the share of repayments on each card to the share of balances on each card”

Suppose a card holder owes $12,000 on one card and $6000 on another one. He can afford to pay $1500 in a month on the 2 cards. There is a greater probability that the card holder will pay $1000 on the first card ($12,000) and $500 on the second one, irrespective of interest rates.

The psychology behind this behavior is that balance is the first thing that comes to mind when card holders think of credit cards.

The balance is shown at the top of the credit card statement in big prints. Moreover, individuals have a greater tendency to use “’matching’ heuristics in decision-making.” Card holders mostly make payments in relation to balances instead of interest rates. They are giving more importance to numbers instead of statements.

Most consumers don’t have any idea of where to start when they have huge credit card debt. They become clueless and thus start repaying debts in completely wrong order.

People are confused. They don’t know how their APR changes their monthly outstanding balance. This involves loads of calculations – daily rates, annual rates, daily balance, etc. It’s not that easy.

What is right and what is wrong?

Tough to say. Some financial experts recommend paying off the smallest debt first due to the emotional motivation. The psychological boost is a big thing for many debtors. Plus, this appears to be the simplest thing to do.

But is this the right financial move?

If you want to keep the maximum amount in your wallet, then this isn’t the best financial move. You should target the credit card with high APR and try to knock it off as soon as possible. Just look at the last part of the multi-page credit card statement. You’ll get the APR information there.

Use free online debt payoff calculators to figure out how much you can pay and save on your existing debt. Use this interactive APR calculator to figure out your yearly interest payments and other expenses. Apart from these calculators, you can use credit card payment calculator for eradicating your credit card balances.

Conclusion

Are you confused like most Americans? Do you want to pay off your credit card debt in the right way? If so, then call or make an appointment with a reputed financial company and get advice on paying off your debts.

tips-and-advice-about-debt-settlement

Best debt settlement advice to consider prior to enrolling in the program

Debt settlement services are normally offered by a third-party organization who can help you to reduce your debts by negotiating with your creditors or debt collectors. You may also negotiate with the creditors and settle your debts on your own. But it also comes with some risks which may create problems for your finances.

Practically, you should usually avoid negotiating with your creditor to settle your debts less than you owe as settling debts may damage your credit score. That’s not all, you might have to pay some tax on your settled amount. In the end, you may notice that you have paid way more than you saved.

If you still consider a debt settlement program, it’s also important for you to do proper research to avoid debt settlement scams.

The sole purpose of this content is to provide you with tips and suggestion on debt settlement. But before discussing further, I would first like to explain the debt settlement process a bit.

How does debt settlement work?

Debt settlement normally lowers the amount of unsecured debts by negotiating directly with the creditor. On the other hand, it is an opportunity for the creditors to collect their unpaid debts as much as possible.

You can settle your debts best when you’re behind on payments. If you’re still current with your debt payments, there’s no logic behind starting a negotiation with the creditor. If the creditor is still getting the money on time, then why should they  accept a settlement offer?

So, you really need to be behind on your monthly debt payments for at least 3 months, if you want to initiate a successful debt settlement process.

Once the process begins, you have the option to make two basic types of settlement plans. In both cases, you will make the offer to your creditor to settle your debts on a lesser amount than you owe. But if you look closely, the payment strategy is quite different. Let’s have a look at the plans:

  1. A single lump sum payment – You can negotiate with the creditors and try to get them to agree for accepting a lump sum payment and settle the account. The amount is usually less than the total debt you owe to the creditors.
  2. A monthly payment plan – You may negotiate with the creditor and arrange a payment plan (usually 4 payments) which will give you several months to repay the debts.

The first option is normally more successful than the second one. Most of the creditors like to get the money as a lump sum payment, rather than getting it on small installments, on a defaulted debt. Typically, the creditors will agree to accept payments under a monthly payment plan if it really make sense to break the total payments over a short time .

You can get help from debt settlement companies, also called “debt relief” or “debt adjusting” companies. The companies will provide you with a debt settlement program to get you out of unsecured debts once and for all. They will get an authorization from you to contact your creditors on your behalf. After contacting, they will start negotiating with the creditors and make a better repayment plan.

Debt settlement companies will usually  charge you a fee, often a percentage of the amount saved by them on your debts.

Now let’s move onto the next stage. Here we will discuss some tips you should consider before settling your debts.

Best debt settlement advice to consider prior to taking help of settlement

1. Be proactive, stop waiting

Don’t wait for reaching out to your creditor until your account has been charged off. A charge off account means you are more than six months behind on your payments. A charged-off account is known to the creditors as an account which has less prospect of getting repaid again. But don’t forget, being charged off doesn’t mean that you no longer owe the debt.

You should contact your creditors quickly and initiate debt settlement. Stop waiting and plan a good settlement offer that the creditor can’t refuse.

If you contact your creditors soon with a positive approach, most of the them would agree to agree with the settlement offer. If you take too much time to ask them, there’s a probability that they might sell off your account to some third party collection agency for a lower value, and that’ll be considered as a loss. So, in this situation, creditors or lenders may do anything to avoid such a loss. So, chances are there that your settlement offer might be accepted sooner than you think.

2. Enroll in a settlement program together if you aren’t single

If you have a spouse or a partner, go and sign up for a debt settlement program together! It is the best debt settlement advice I can give you to maximize your savings. But, you must first consider these things:

  • Which one of you is just an authorized user on these accounts?
  • How much debt do you have alone?
  • How much debt is in your spouse’s name?
  • How much debt do you have in both of your names?
  • Does it make sense to settle both of your debts, or only one of yours is OK?

If you and your spouse have $60,000 in credit card debt but $45,000 of it is in your spouse’s name, it would be wise for you to maintain your payments instead of settling your debts.

This way, one of you will be able to maintain your good credit. So, if a situation comes where you need a better credit, before re-emerging from the effect of debt settlement, you’ll have a good credit record with you.

3. Don’t make an unrealistic offer

If your creditor is ready to accept your offer and allowing you to settle your debts through monthly payments, you must set the payments at a level where you can afford it financially.

When you start negotiating with the creditors, try not to set a debt settlement plan that is unrealistic.

Most of the time, debtors, who offered a big amount as monthly payments, are able to make only the first payment and then miss rest of the payments. As a result, they fail to carry on with the debt settlement payment plan. In such cases, the account may be referred to a collection agency.

4. Consider the estimated time of the debt settlement program

Some people might think that settling debts may take just a phone call to the creditor and a couple of months to complete the process. But this is not the truth. Negotiating with the creditors may take time. The creditor must accept the settlement offer and agree with the terms you are adding with the offer. Sometimes the creditor may also give a counter offer.

In the end, you and your creditor should find a common ground to agree with each other.

But, taking too much time to settle your debt may also increase the chances of a third party involvement.

Why? It is because while you’re negotiating for debt settlement, you’re already behind on your payments for at least 3 months. If you take more time, your creditors may become restless and transfer the account for collection. You might be sued if you are delinquent for 12 to 18 months. So as soon as you are ready to eliminate your debts through a debt settlement program, you should always check the approximate duration of it.

5. Rebuild your credit with proper planning

Debt settlement may harm your credit score almost as bad as bankruptcy. The exact impact on your credit score may vary depending on the other information on your credit report. But, if you have a FICO score more than 700, your credit score may get a blow between 140 to 160 points.

You need to stop your debt payments for 3 months (at least) if you want to join in a debt settlement program. Once you settle your debts, it’ll be reflected in your credit report as “paid settled”. You need to stop your debt payments for 3 months (at least) if you want to join in a debt settlement program. Once you settle your debts, it’ll be reflected in your credit report as “paid settled”.

In this situation, you need to stay calm and focused on rebuilding your credit score. There are some good ways to do the same:

  1. Check your credit report – Check your credit report on a regular basis from your 3 major bureaus. Dispute errors if you find any and try to remove bad items asap.
  2. Catch up on your delinquent payments – After settling your few accounts, try to keep up with your other credit accounts and make the  missed payments.
  3. Pay Your bills on time – If you are getting any new loan or credit cards, make sure to pay the bills on time and in full.
  4. Don’t close old credit card accounts – After settling your credit cards, do not close the accounts. Old credit accounts have a long payment history; use them to rebuild your credit.
  5. Maintain good financial habits – Track your spending and prepare a suitable budget to allocate your money in different categories. Avoid excessive shopping and use cash rather than a card. Increase your retirement fund 401(k) whenever you have money in your wallet.