Three tips for paying down debt if you’re facing record-high credit card debt this year, too.
American consumers hit a big milestone at the end of last year when we hit $1 trillion in credit card debt. Experts worried that families were reaching unsustainable debt levels, meaning many might be headed for financial hardship. However, a new study from WalletHub finds that consumers repaid $40.3 billion in the first three months of this year. But is that enough to get the average household out of the danger zone when it comes to credit card debt?
How much do Americans owe?
Americans charged in record numbers in 2017. We added $91.6 billion in new credit card debt over that 12-month period. That’s the highest single-year spending since the start of the Great Recession in 2008.
According to WalletHub’s data, the average household owes $8,166. WalletHub’s credit experts believe that’s getting dangerously close to what they call an unsustainable debt. Basically, when a household owes more than $8,500, it means financial hardship is almost certain. It can lead to credit damage, closed accounts and even bankruptcy.
The binge and purge cycle of credit card debt
The good news is that Americans seem to have stopped charging so they can focus on paying down debt. We eliminated $40.3 billion in the first three months of the year. But that doesn’t mean that the crisis has been completely avoided. In fact, this isn’t the first time that American consumers have shown a big reduction after a big gain. It’s a pretty normal cycle:
As you can see from the chart, we tend to have a quarter with big payoff after each quarter of overspending. And the peaks of overspending are gradually getting higher as time passes. It’s basically a financial binge and purge cycle.
- You overcharge because you have an expensive few months and need credit to cover gaps in your budget.
- You panic because you see your bills are so high, so you commit to stop charging.
- Then once you’ve paid down some debt, you relax and start charging again.
“The problem with this cycle is that most people don’t reach zero before they start charging again,” says Gary Herman. “In fact, we tend to charge more during the binge part of the cycle than we pay down during the purge. As a result, your debt gradually increases over time. You slowly creep closer and closer to financial distress, until one day you find it’s a struggle to keep up.”
Herman says there are some key steps that people can take to avoid letting this cycle continue.
3 Tips for Paying Down Debt to Break the Cycle of Overspending
#1: Develop a balanced budget with built-in savings
“There are two main reasons why people pull out the plastic to charge,” Herman explains. “You use credit cards to cover daily expenses that you don’t have enough income to cover, or you pull out the plastic anytime you have an unexpected expense outside your budget.”
This is why Consolidated Credit recommends creating a budget that includes built-in savings. This allows you to ensure that you cover all your daily expenses, as well as unexpected expenses that always come up. Experts say you should save 5-10% of your take-home pay each month. But even if you just set aside even 1% of your income each month, that gives you more breathing room. You can use savings to cover unexpected expenses, instead of using credit cards.
#2: Reduce or eliminate interest charges
“One of the biggest challenges that you face when paying down debt is interest charges,” Herman says. “If you’re only making the minimum payment, then two thirds of every payment you make covers accrued interest charges. You may only pay down the principal a few dollars at a time.”
The solution is to reduce or eliminate interest charges that apply to your debt. That way, you can pay the principal off faster, because more of the money you pay goes to eliminate your actual debt.
“If you owe more than $5,000, it’s time to get debt relief,” Herman continues. “For people with good credit, you can look into options for debt consolidation. If you don’t have good credit or you owe more than $20,000, then you may need some help. You should talk to a credit counselor to learn about relief options you can use to get out of debt.”
#3: Force yourself to stop charging
“You don’t want to get complacent just because you pay off a portion of what you owe,” Herman explains. “You really want to eliminate your debt in-full before you start making new charges. If you can’t stop charging on your own because you’ve become credit-dependent, then you need to find ways to force yourself to stop charging.”
This is one of the benefits of enrolling in a debt management plan through a credit counseling agency like Consolidated Credit. Any credit cards that you include in the program are frozen. That means you can’t make any new charges on those cards until you have your debt paid off. This can be an advantage, because it forces you to break any bad credit habits that you’ve developed.
“If you’re trying to eliminate debt on your own, then find creative ways to freeze your accounts yourself,” Herman encourages. “One of the favorite tricks we recommend is to literally freeze your cards. You fill a few cups with water, drop your credit cards in and freeze them. That way, if you want to make a charge, you must wait for the ice to melt. That gives you ample time to reconsider the purchase. You’re much less likely to make the charge.”
Herman says this can be an effective way to force yourself to break a bad credit habit. It’s particularly useful if you use a debt consolidation loan or balance transfer to consolidate your debt. When you consolidate, it zeros out your existing balances, but the accounts stay open. So, it’s all too easy to run up new balances if you don’t put measures in place to stop yourself.