The Most Important Part Is Starting: Debt Recovery

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I was recently chatting with a friend of mine about finance when she stopped me and asked, “What is APR? I have a good chunk of credit card debt and don’t even know how to get started repaying it.”

This brought to mind an interesting thought. How many people are in debt and don’t even know what their APR is on that debt? or what APR is in general? Some people may be trying to learn and get on the track to debt free life but don’t know where to begin. Well, this post is directed at those people. This will give you a basic understanding of how to get started as well as direct you to places you can learn even more about it, because contrary to popular belief, I do not know everything… 😉

How does a credit card work?

Essentially one will apply for a line of credit from a credit card company. That company will look over anything they can to get a look at if this individual is going to take the money and run or if they are credit-worthy. The majority of this information comes from a consumer credit report about the person which includes past and present lines of credit, how long the person has had credit, as well as a credit score. If the individual gets approved for the credit card, a line of credit is opened for a certain amount (the maximum on the card) and that person can begin spending money on the credit card. Any money spent on the card is charged to an account with the card issuer, they keep track of what has been spent and charge a percentage of that in exchange for the ability they give to use the line of credit. You also have to pay a percentage of the total balance back to the company each month, which is called the minimum payment. That payment is usually around 5% of the total but it’s not set in stone and recently certain credit card companies have been changing their policies and requiring a higher minimum payment, so be aware.  Basically, you get charged a percentage of anything you spend on the card. The amount you get changed in interest then gets added to the balance that you have on the card from your spending.

What is APR?

APR stands for Annual Percentage Rate. It is the rate in which the credit issuer charges you in interest for being able to carry a balance on your credit card. A simple way to figure out the interest rate one is paying is to take the amount that is on the card, multiply it by the interest rate and then divide that by 12. That will give you the amount that is being charged for having that particular balance each month. This method is not completely accurate because interest actually compounds onto the card at different rates than yearly, most commonly at the end of each month and I am not a mathematician. The amount being charged to the card will actually be more than this calculation estimates, but it will give an approximation of the amount.

So as an example, this particular friend of mine has about $10,000 on credit cards. One of the cards in particular has a 30% interest rate. She has $3,500 on that card. So to find out what she is paying on this card, take 3500 multiplied by the interest rate of 30% or .30 which comes to 1050. Divide that by 12, and that gives us about $87.50 per month or almost $3 a day! Now this is a ridiculously high APR but even with the more common 18%, the interest payments are painful. To put this information in context a bit, say the minimum payment on this card is 5% or $175. If my friend only pays the minimum payment on that card, after the interest is added to the card, her payment is actually cut in half and only $88 of that actually gets paid towards the money owed on the card. By the time she is done paying off this card, she will have literally paid for her purchased several times over.

How do I know what APR I signed up for?

If you already have the credit card, you can either call the company (the customer service number listed on the back of the card) and ask them what the interest rate is, or you can pull out that paper statement that the company sends you each month that tells what your balance is and what the minimum due is on the card. On the statement it should say somewhere what your APR is and it should also list the finance charges on that statement. The finance charges are what the company calls the interest payments you make for having a balance on the card.

Something else that should be taken seriously is the Credit Card Terms and Conditions. This will also tell the APR for your card, and it will give a basic rundown of how the interest will be compounded, or added to your balance and what will happen if you miss a payment. Here is an example of part of a credit card Terms and Conditions, explained very well over at ‘StopBuyingCrap.com’.

Annual Percentage Rate (APR) for Purchases: This is the annual rate you’ll be charged if you carry a balance from month to month. In a credit card offer with an introductory rate, this is where you’ll also see it listed. For our example, the APR for purchases is 9.99%.

Other APRs: This is where other annual percentage rates for other types of transaction are listed. Take our example, it’s balance transfer APR is 9.99% and it’s special opening cash advance is also 9.99%; however, it’s regular cash advance is 19.99%–a hefty interest rate. The delinquency APR is an even higher 23.99%.

Variable-Rate Information: In this box, you’ll see how your variable rate is determined. Generally, the purchases APR will be a variable rate, such as 3% + the Prime Rate, while the balance transfer APR will be a fixed rate. There’s generally also a footnote with an explanation on how prime rate is determined—usually by the highest prime rate published in The Wall Street Journal on the last business day of the month.

How do I get started?

Get your annual credit report and credit score.

One of the most important tools for someone trying to get out of debt is their annual credit report. This report gives a pretty detailed rundown of what shows up on a persons credit file. It will show anything that has had a negative impact on a persons credit as well as detailed history of previously opened, closed, and current credit accounts. It will show how many inquiries someone has had on their credit report and who was looking into it. The best part about the annual credit report is that its free, once a year. However, this report does not show one’s credit score.

A credit score is a score given to you that somewhat represents your credit worthiness. The interest rate you will be charged on your credit card is based partly on your credit score. It is a good idea to check on your score once in a while. To get this score, you can either purchase it from a company such as myFico or you can go through a newer company that has recently been getting some good press called Credit Karma which will give you your credit score for free. There are a few other companies that have “free credit reports” but in reality most of them will only give you the credit score if you sign up for some special program that comes with a nice monthly fee. I would advise staying away from any more monthly fees if you have credit card debt.

Start a more hands on approach with your accounts.

Like my friend, many people have more than one credit card account, as well as multiple bank accounts. It is hard to keep track of all these accounts without some help so create a system to keep track of your accounts. Some people will see no problem in using a simple notebook and pencil but many of us are not that disciplined and have a hard time keeping everything straight. I would suggest signing up for Mint.com which I have previously reviewed. It is a great system, very easy to use and automatically will update you via email or SMS to your phone about your account balances, bills that are due and any unusual activity on any of your accounts including if a credit card interest rate has changed. There are also alternatives to Mint.com and you can see some that ‘Poorer Than You’ has compiled here.

Start a budget.

‘No Credit Needed’ has done a great job explaining how to set up a zero based budget. A zero based budget is essentially a plan to follow that does not allow money to fall through the cracks. All of your income will be allocated to a certain place and every penny will be accounted for. This creates a great structure for you to follow so that you will not feel like you have “extra cash” in any given month that will be spent frivolously. If the thought of not spending any money on anything other than debt makes your cringe, you can allocate a certain amount of “fun money” in your zero based budget plan but be reasonable with yourself. The reason to set up a budget like this is to pay down debt and get your finances under control.

Transfer balances and negotiate better rates.

There are many ways to help ease the pain of credit card debt with high APR. The first thing to do would be to try and get the balances transferred off the high APR credit cards to a lower interest rate credit card. How this usually works is you can find a card that has a lower interest rate than the card you currently have and transfer your balance to that card. In my friends case, anything under 30% would work. Many cards will offer a temporary APR of 0% on balance transfers for a certain amount of time. Be aware that many of these cards do charge a fee for the balance transfer, which is usually about 3% of the total amount of each transfer. Many of these will also have a maximum fee which is a great thing to look for if you are transferring a huge balance because. Here is a list of instant approval credit cards that have good introductory rates for purchases and balance transfers, and have a decent interest rate after the introductory rate. The card I used is the American Express Starwood Preferred card which has a 2.9 intro rate and no fee for balance transfers. After you transfer your balance off the card, cut it up and stop using it but don’t close the account as that can hurt your credit score. If you ever need, you can always order a new copy of the card.

After exhausting the balance transfer method to decrease your APR, try calling your credit card companies and asking them to decrease your rate. Chances are they can and will decrease your interest rate somewhat and any little change helps. According to CBCnews six out of ten consumers they approached at random were able to get their APR lowered by calling the company and asking.

Start snowballing or snowflaking.

After preparing your spending plan and lowing the APR on your revolving balances, you need to pound that debt as hard as you can. One popular method is the “snowball method” but Paid Twice has actually taken that method a step further with her debt snowflaking method:

Well, what are snowballs made of? Snowflakes! I have a set amount I pay to debt without fail every month that is above my minimum payment due (about $800). On top of that, I also try to collect up little bits of money wherever I can and I apply those as well to my top priority debt as immediately as possible. I take surveys online, I sell possessions on craigslist and ebay, I have yard sales, and any money I get from these endeavors goes directly to my debt. I also keep a very strict accounting of all the money that comes in every month and what I spend and everything left over at the end of the month not earmarked for future expenses also goes directly to debt. These are my snowflakes. I have averaged over $200 extra going to pay down my credit card debt every month due to these snowflaking efforts.

She also has defined five golden rules that she follows with her debt snowflaking method. One in particular caught my attention because I hear people say all the time that “its only a dollar” when it comes to small impulse buys. However, all of these rules are excellent and should be followed in every way possible.

2. No amount is too small to be a snowflake

I have snowflaked as little as $1.04 and as much as $1313.74 and everything in between. Any amount can be a snowflake, and any amount can make a difference. Especially when you are dealing with a debt that has interest charged to it (which most are) or putting money into savings earning interest, don’t wait to get to a certain amount before applying that snowflake. Whatever the amount – snowflake it.

You can also get a free debt snowball calculator here as well as a free budget calculator here. The calculator will let you prioritize your debt payments depending on interest rates and total balances, or however you like. With the calculator you can see exactly how long it will take to pay off your debt, allow you to record your exact payments, and even add in small snowflakes you happen to be able to pay to your debt. Having a detailed plan of when you may be able to finish your debt really helps. As I have said before, the power of visualization is pretty strong.

The best thing you can do is get started. The longer one waits to get debt under control, the longer the debt will pile up.




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11 People have left comments on this post



» Wealthier Every DayNo Gravatar said: { Mar 7, 2009 - 11:03:14 }

Great comprehensive post! It’s easy to dismiss the impact that $1.04 can have on your debt pay-down, but every bit does truly help. To your point, staying motivated and focused on your goal is essential to success.

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Jesse MichelsenNo Gravatar Reply:

Hey, thanks for dropping by. That is exactly right, even if the $1.04 only takes $1.04 off the debt it still helps to keep one motivated towards a goal, shrinking that huge weight on one’s shoulders.

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» JoanneNo Gravatar said: { Mar 8, 2009 - 03:03:08 }

Great article! It contained a lot of useful information for the consumer! Here is a site I have visited that gave good information on budgeting, loans, etc. http://money.lessonstudio.ca/

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Jesse MichelsenNo Gravatar Reply:

Great! I am always looking for new sources of information. Thanks for visiting and sharing Joanne.

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» Credit Card ChaserNo Gravatar said: { Nov 23, 2009 - 08:11:57 }

Good advice because once people start to see the effects of a high APR then they will think twice about ever carrying a balance in the first place! I use a cash back credit card but just pay off the balance in full each month.
.-= Credit Card Chaser´s last blog ..Credit Cards & Bankruptcy: A Visual Tragedy =-.

[Reply]

Jesse MichelsenNo Gravatar Reply:

Thanks for the comment CCC, and I do something similar with my purchases. I use an AMEX charge card. The total amount is due each month, there is no interest and I use it primarily for the points.

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» Trey - @treyhallNo Gravatar said: { Sep 5, 2010 - 05:09:23 }

This is excellent work Elle. Would you agree that using local/community bank credit cards would be beneficial as you are treated as a person rather than a number as in megabanks? We did this a while bank and it has been hassle free. Keep up the good work this is an awesome site.

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{ Feb 21, 2010 - 10:02:30 } Carnival of Debt Reduction


 
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