Thursday, February 8th, 2018
Credit cards offer many benefits: building your credit score, managing your cash flow and earning rewards, but credit card interest isn't one of them. Credit cards can be a powerful financial tool, when they're used responsibly.
There are many reasons you can find yourself with credit card debt. Overspending and financial emergencies are common reasons. In today's increasingly cashless society, it's easy to lose track of your spending, especially when you're using your credit card instead of paying in cash. Financial emergencies often come up out of the blue. For example, my furnace recently broke and I had to pay $1,300 to repair it.
It's hard to save for a home or qualify for a mortgage when you have a lot of credit card debt weighing you down. One of the calculations lenders use before approving your mortgage is the Total Debt Service (TDS) ratio, which adds up your mortgage payment, property taxes, heating expenses and other debt expenses per month and divides that total by your monthly income. If you're carrying credit card debt, it can impact your ability to qualify for the mortgage amount you want.
There are many good reasons to get rid of debt as quickly as possible. As I reveal in my new book, Burn Your Mortgage, there are two popular ways to pay off your debt sooner: debt avalanche and debt snowball.
With the debt avalanche method, you'll pay down the debt with the highest interest rate first. For example, let's say you have Credit Card A and Credit Card B. Credit Card A has an interest rate of 18 percent, while Credit Card B is a retail credit card with a higher interest rate of 29 percent. Using the debt avalanche method, you'd focus on paying off Credit Card B since it has the highest interest rate (while still making at least the minimum payments on Credit Card A).
With the debt snowball method, you'd pay off the debt from the smallest to largest balance. Think of it as rolling a giant snowball down a hill. It starts small, but gets bigger and bigger as it collects more snow. Going back to our first example, if Credit Card A has a balance of $1,000 and Credit Card B has a balance of $3,000, you'd focus on paying off Credit Card A since it has the smaller balance (even though Credit Card B has the highest interest rate). Some people find this way more motivating. Just make sure you keep paying at least the minimum payments on Credit Card B to keep your credit in good standing.
The debt avalanche and snowball methods don't just work for high-interest credit card debt. They work for other forms of debt, such as student loans, lines of credit, payday loans and mortgages.
There's no right away to pay off debt that works for everyone. It's about choosing the method that works best for you and keeps you motivated. The sooner you pay off your debt, the better. If your debt is getting smaller, you're moving in the right direction.