Debt is a part of life. Whether you’ve taken out a student loan, financed a vehicle or home, or have simply fallen behind on your bills, there’s a good chance you will be in debt at some point. To ensure that you’re able to pull yourself back into the black as soon as possible, you should understand how to effectively manage your personal finances while in debt, especially your credit cards. Learning how to manage your credit cards while in debt can not only help you avoid putting yourself deeper “in the hole,” but it can actually help you lower the overall cost of your total debt obligation.
- Identify Your Debt
What type of debt are you holding? Is it a student, home, or auto loan? Outstanding medical bills? Are you currently carrying balances on your credit cards?
In addition to identifying the type of debt, be sure to understand the repayment details. How much do you owe today, and what is the annual percentage rate (APR)? How often are you required to make payments, and what is the minimum payment amount?
Correctly identifying the type of debt you are holding is very important, as it will determine how you can best use your existing credit cards to help manage it, if at all.
- Identify Your Means
Now that you understand your debt, you need to understand your means of eliminating it. What is your current cash flow situation (i.e. how much money are you bringing in monthly)?
Just as importantly as how much money you’re earning, how much money are you currently spending on living essentials? Living essentials should only be those things that you couldn’t live without (e.g. rent, gas, food, etc).
Knowing how much money is left after you’ve paid for living essentials will give you the amount that you have available for paying down your debt; however, you shouldn’t necessarily spend this entire amount on repaying your debt each month. Depending on the type of debt you are carrying, the repayment terms, and your available means and credit, you might opt to spend less.
Would a Debt by Any Other Name, Cost as Much?
While it’s easy to lump all “debt” together, the reality is that not all debt is created equal. Some types of debt are designed to be repaid over a long period of time (e.g. student and home loans), and as a result they have much lower APRs than other, short-term debt. The total amount and APR of your debt are two of the most important factors for determining how you can best use your credit cards to help manage your repayment.
- Identify Your Available Credit & APR(s)
How much available credit do you have on your credit card(s)? What are the APR rate for the card(s)?
This available credit can also be viewed as available debt, which is why the total amount and APR are so important. If you have sufficient available credit to repay your existing debt, and the APR rate on your card(s) is lower, it might be beneficial to transfer the balance of that debt to the card(s).
The process mentioned above is known as “balance transfer,” and it is one of the principal ways that your credit card(s) can help you manage debt. Don’t worry, we’ll discuss balance transfers in greater detail in a moment.
- Identify the Best Use of Your Credit Card(s) for Managing Your Debt
Now that you have an understanding of your debt, your means of repayment, and your available credit, you can compare different strategies for managing your credit card(s):
- Balance Transfers: As mentioned above, this is a process by which you can transfer the balance of your debt to a credit card with sufficient available credit. This is most commonly done to avoid carrying a balance on a credit card with a high APR. As the cost of your debt is the principal amount plus accrued interest, carrying the balance on a card with a lower APR can reduce the total cost repayment.
In order to transfer a balance to one of your credit cards, you will most likely need to pay a balance transfer fee. This fee varies depending on the card, but typically it can be anywhere from 1 – 5% of the balance being transferred. One way to avoid paying this fee is to see if your credit card(s) currently has any promotional offers available. It is common for banks to offer promotions that waive the balance transfer fee, and in many cases also give a promotional APR rate for a set amount of time after the transfer (sometimes this can be as low as 0%).
- Credit “Bridge:” It’s possible that you have debt that requires a payment, but that it comes at a time that finds you with insufficient cash flow to cover the expense (e.g. a payment is due prior to a paycheck being issued, which would allow you to pay in full). In this case, you may consider using your available credit to either cover a portion of the debt payment, or to cover a portion of your essential living expenses (thereby freeing-up additional cash for the payment).
While there is nothing inherently wrong with using your credit card(s) this way, you should exercise restraint. For example, if an unexpected expense arose during the month that caused cash to run short prior to a payment, this would be an appropriate way to “bridge” the time between the debt payment and when your cash flow resumes. If you find yourself chronically using your credit card this way though, you run the risk of incurring even more debt by regularly carrying a balance on the card.
- Tighten the Belt: Although credit cards can be a great tool when managed correctly, they also can be the source of a debt problem themselves. If you find yourself carrying excessive credit card debt (i.e. consistently carrying balances you are unable to pay, causing you to remain in debt), or have other debts that are so great you are unable to make the regular, minimum payments, do not use your credit card(s) to continue sustaining your current spending habits.
At the end of the day a credit card is debt, and there is no way that using one can in and of itself move you closer to financial solvency. If you find yourself carrying debt that you are unable to make regular payments on, you should refrain from adding to that burden for all but the most extreme emergencies.
- “Convenience” Card: If the debt you are carrying is primarily long-term debt, such as student, home, or auto loans, than it is quite possible that you are able to make your minimum payments without issue. This type of debt is usually quite large, and is designed to be repaid over a long period of time. As such, it is not practical for you to exhaust your cash flow each month on payments. With much lower APRs, these types of loans are usually issues with an understanding by both parties (the borrower and lender) that the interest accrued is simply the “price” of taking the loan.
In these situations, using a credit card for convenience is completely appropriate. Just be sure that you are not using the cards excessively, and that you are able to pay off your balance in full. As long as you are not growing your overall debt by consistently carrying balances on the cards that you are unable to pay, there is no reason that you should hesitate to use them.