October 4, 2008

Bailing Ourselves Out, Part 3: Credit Cards

The $700 billion bailout bill has passed both the House and Senate and been signed by the President. But will it really help end the current financial crisis? I'm feeling pretty skeptical about that, and I'm hearing a lot of skepticism from others as well. While we wait to see what future this Emergency Economic Stabilization Act and its add-ons will carve out for America, let's all do something to help the overall situation. This post is my third in a series on ways regular, everyday people can address the causes and concerns of the financial crisis in their own lives.

Part 3: Cut down (or cut up) your credit cards.

Credit cards can be a wonderful tool for building your credit score and history, as well as helping you make important purchases with added consumer protections. Unfortunately, they can also be hugely destructive in the wrong hands, burying the cardholder in mountains of debt they can't afford to pay.

Part of the reason the financial world is such a mess right now is that over the last few years, it's become the norm in America to spend like there's no tomorrow. Most people spend what they earn instead of saving it, then spend even more than that by putting purchases on their credit cards (vacations, computers, flatscreen tvs, you name it) without thinking about whether they can really afford those items. Many people, myself included, have gotten credit cards intending to use them "for emergencies only" but ended up using them for frivolous spending.

If you have more than two or three credit cards, consider that you may have too many. If you are carrying balances on any or all of them that you cannot pay back at the end of the month, you definitely need to take a hard look at your situation. Credit cards are not magic -- the money has to be paid back, and the interest charges every month mean you'll only owe the company more.

Make a plan today to cut down on your credit card use. Make a list of your cards with their current balance, interest rate and credit limit. Then look at the list and decide on a plan of attack. Some people, like those who use Dave Ramsey's snowball method, pay off the card with the smallest balance first so they have a quick victory to encourage them to continue. Others go for the card with the highest interest rate, so they'll immediately pay a lower percentage of money for interest fees. You can also consider what the cards do for you. If you have one card with particularly good rewards, you might want to keep that one and get rid of any others. Or if you really want to have one card for emergencies, pick one with a limit high enough to cover any serious problem and get rid of the rest. (Of course, having an emergency fund is the best choice to plan for those situations, so if that's your motivation you should also start putting small amounts of money away every week or every month. That way, you'll eventually have emergency funds in place and won't need your credit card.)

Once you've targeted your first card to eliminate, make your minimum payments on your other cards and put all available cash toward the balance on the card you are eliminating. When you've paid the balance down to zero, cancel the card/close the account.

Closing a credit card account puts a small negative mark on your credit score. If you are planning to buy a house or car, or something else that will require financing in the next six months, don't close your paid-off credit card account. Just cut up the card so you can't use it for any additional purchases. After your mortgage or loan is in place, then you can close the credit card account.

And after you've set up a card payoff plan, cut down on your credit card spending. Don't make a plan to get out of the hole and then dig yourself back in again. Look carefully at the types of purchases you've been making on your card(s) and look for patterns. Do you tend to charge big-ticket items? Save up for them instead by setting aside small amounts on a weekly or monthly basis. Some places will even give discounts if you pay cash for large items.
If your charges tend to be recurring impulse buys at a few particular stores, avoid those stores! Yes, I mean it. Do not pass store, do not spend. And if you have a habit of charging your morning breakfast at Starbucks or expensive dinners out every night, scale back. Make breakfast or dinner at home a few times a week and give your cards (and your cash) a break.

We created this credit-driven, flash-driven, try-to-beat-the-Joneses culture in America. We need to be the ones who dismantle it and replace it with a healthier model that benefits everyone.

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