Monday, 16 May 2011

Get rid of credit card debt with the Balance Transfer and the 20% Rule

by Rob d'Apice
Let's be clear: credit cards aren't for everyone.

So far in this blog, we've spent a lot of time focusing one (key) part of becoming more financially empowered: getting the right information on how to optimally use financial products.  But this can only ever be part of a money solution; as with many things in life, most of us know what we should be doing (not spending as much, eating better, exercising more, etc.) - but we still choose to buy things we can't afford / eat that whole tub of ice cream / put off going to the gym.

Managing debt is then part-scientific and part-behavioural; that is, getting the right information AND translating that into easy-to-implement principles to change your behaviour.

So: you have a big credit card debt?  We could say: "Stop spending and slowly pay it off over time.  Easy!" - but that doesn't help you (and, really, you already know you should do that).  So, here's our take on the best way to get out of credit card debt, mixing our knowledge of financial products and consumer behaviour.

Step 1: Balance Transfer your debt

Haven't heard of Balance Transfers?  Many banks offer a special deal if you transfer your existing credit card debt to their credit card; they give you a temporarily discounted interest rate on the transferred debt.  The saving can be very serious - from a 20-25% interest rate on your current card, to 0-6% on the new Balance Transfer card (generally for a period of 6-12 months).

How much could this save you?  On a $5,000 credit card debt, undertaking a Balance Transfer for a 12 month period could save you more than $1,000 on credit card interest.

Prosple will be the best way to find the right Balance Transfer deal for you; but for now, here are a selection of some of the good ones:

Step 2: Cut up ALL your credit cards

This is absolutely key. You've just transferred all your debt from your current card. That is not a blank cheque to start spending again. Cut up this credit card straight away. Then call the bank and cancel it. If any bank says "you can't cut up cards until you've done X, Y or Z": don't listen to them. They want to keep the temptation there for you, that's all.

Then: when your new Balance Transfer card arrives in the mail, CUT IT UP STRAIGHT AWAY. Spending on a Balance Transfer card is an absolute disaster. Interest-free periods are forfeited while you have the Balance Transfer. Any repayments you make go toward the Balance Transfer amount (low interest), and not your high-interest recent purchases - which is useless to you. Cut it up and get the debts out of your life.

Want to get really pro?  Instead of cutting them up, you can turn them into these nifty earbud holders.  Take that, Apple! (Thanks: Hamish)

(BTW, if you don't want to cut your cards because you need Visa or Mastercard facilities, you should get a Visa or Mastercard debit card that is linked to your savings/transaction account. We'll explore this more in a later post.)

Step 3: Set up a repayment plan (Use the 20% rule)

Your credit card debt isn't going to go away over night. It's going to take time and work. But you'll feel so much better when it's gone (and you can then start saving money, which means actually building wealth for the future).

Use the 20% rule. 20% of your earnings should go into repaying your debt. If you can stomach more, then set it higher. But set it and stick to it religiously. As soon as you get paid, transfer the 20% into your credit card. Yes, this will hurt, but all the pain will go away when you are debt-free. This strategy means that if you earn (say) $600 a week post-tax, you could pay off a $5,000 debt in less than 10 months.

Want to know how long it'll take you? Moneysmart, a recently launched government initiative to improve financial literacy in Australia, have a tool for calculating credit card debt repayment times. Have a play with it to see how soon you could be debt-free - or post in the comments below and we'll help you look into it!

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