The U.S. debt crisis continues to capture headlines—and rightly so. Servicing the nation’s $31.38 trillion in debt is one of the federal government’s biggest expenses. According to the Office of Management and Budget, net interest payments on the debt are estimated at $395.5 billion this fiscal year, comprising 6.8% of all federal outlays. As the Fed raises rates to try to cool off the economy, the U.S. is paying even more to borrow. Pew Research reports that the average interest rate on federal debt last year ticked up to 2.07%.
Many U.S. households are experiencing a debt crisis of their own, as the one-two punch of rising interest rates and inflation has led more Americans to lean on credit cards to make ends meet. While certain types of debt, such as mortgages or student and small business loans can be useful for pursuing important life and career goals, other types of debt, such as credit card debt, can be an obstacle when it comes to accomplishing your goals. According to a recent report from TransUnionTRU, total U.S. credit card debt reached a record $930 billion in the fourth quarter of 2022, an 18.5% increase from a year earlier, bringing the average debt per borrower to $5,805.
While credit cards can be a safe and convenient way to pay for purchases, carrying large amounts of credit card debt can rob you of your financial freedom now and for years to come. That because when credit card debt is not carefully managed, it can become crippling due to the high interest rates applied to outstanding balances. In fact, the average annual percentage rate (APR) for interest paid on outstanding credit card balances as of March 1, 2023 was 19.94%.
Also keep in mind that how you use your cards can make a difference in how much interest you may be required to pay. That’s because card companies often charge one interest rate for purchases and a different rate if you use your card to get cash, or other transactions. If your card has a grace period, you may be able to avoid paying interest on purchases if you pay off your balance in full by the due date each month. However, the grace period generally only applies to new purchases and only if you were not already carrying a balance. Your credit card statement is required to show each category along with its corresponding APR and the dollar amount of the balance that falls into each category.
Managing your way to financial freedom
While few people have the luxury of going through life without incurring some form of debt along the way, how you manage that debt can make all the difference when it come to pursuing your desired outcomes. When used judiciously, credit cards can be a useful tool for building your credit history and maintaining a strong credit score, which lenders use to help determine your creditworthiness and the interest rate you will pay. Qualifying for the best possible rate is important because the less you pay in interest, the more you keep for yourself.
If you’re saddled with high credit card debt, there are a number of ways to not only manage it but get out from under it. Doing so will free up more money for emergency savings and important long-term goals, including retirement.
1. Pay off outstanding balances. Paying account balances in full each month is one of the best ways to increase your credit score over time while avoiding the high interest rates credit card companies typically charge on outstanding balances. But what if you’re not in a position to pay off a large balance in full?
2. Double up on monthly payments. Unexpected expenses, budget constraints, overspending and other circumstances can lead to higher balances than anticipated and the need to spread payments over time. However, this can become costly, especially if you’re only paying the required minimum due each month. For example, if you have $5,000 in credit card debt and only pay the minimum due (interest + 1% of principal, for this example), it would take nearly 23 years to pay of the balance, based on Bankrate’s minimum payment calculator. Equally concerning, you would pay more in interest over that period of time ($6,923) than principal ($5,000) for a total of $11,923.
Doubling up on monthly payments can help pay off balances much faster and save you hundreds, and in some cases thousands in interest due. If you can’t double your payments, make sure you’re paying more than the minimum due. Every little bit above the minimum will help pay off those balances sooner.
3. Consider a balance transfer. In many cases, balance transfers can help consumers pay off high credit card balances faster. A balance transfer involves moving debt from a credit card with a high APR to a new card with a lower interest rate and, ideally, a 0% introductory rate. The 0% introductory period offers a temporary break from interest charges, providing a window of opportunity to pay down debt more aggressively. While balance transfers can help you save money by paying off debt faster, strict rules and guidelines apply, including stiff penalties and fees in the event of late or missed payments or other violations of account terms and conditions. So, make sure you read the small print before initiating a balance transfer.
4. Ask for a lower rate. If you prefer to remain with your current provider for the cardholder benefits or rewards, consider asking for a lower interest rate. Before contacting the issuer, take time to review the APR and account holder terms and conditions on your current account, your credit score and payment history, and competitor offers. This information can be useful for stating your case when seeking a lower rate.
5. Consolidate debt. If you have multiple credit card balances, it may make sense to consolidate debt through a lower-interest personal loan. This can help reduce costs while streamlining debt management. However, to qualify for the most favorable terms and rates, your credit score will need to be in the “good” to “excellent” range. For information about managing your credit score, visit myFICO.com.
6. Build emergency savings. Poor budget management—or the lack of a budget—can lead to credit card debt and a lack of adequate emergency savings. Your emergency fund helps to pay for some of life’s unanticipated moments, such as a trip to the emergency room or an expensive home or car repair that you didn’t see coming. Without adequate emergency savings, many people are forced to turn to family, friends or credit cards to help pay for these expenses. In fact, a recent survey reports that 57% of U.S. adults are unable to afford a $1,000 emergency expense and 35% carry credit card debt from month to month, up from 29% a year ago.
That leads to the age-old question, which is more important, paying down credit card debt or building savings? The answer is both—and here’s why. Circumstances that we can’t anticipate will continue to happen. That’s just life. However, without adequate emergency savings to pay for these unexpected expenses, you end up on an endless hamster wheel. As soon as you pay down a portion of debt, you’re forced to add new debt because you didn’t have the savings built up to help cover these new, unanticipated expenses.
To build or bolster your emergency savings, commit to depositing a portion of each paycheck into your emergency savings account. Many employers will help you do this through your payroll direct deposit elections. If your employer does not offer this option, or if you’re self-employed, set up an automatic monthly transfer from your checking to your savings account. Even if you can only save a little each month, doing so consistently will add up over time and you’ll benefit from the power of compounded interest, which makes your money grow faster, as long as savings are in an interest-bearing account.
I’ve always believed that true wealth lies in our ability to experience life the way we choose and with the people we choose to spend it with. As a result, there’s nothing more freeing than the ability to live within your means, regardless of the level of income you generate. However, doing so relies on making choices throughout your life that truly put your best interests first, including saving for future goals and managing debt.
To learn about steps you can take now to pursue the financial freedom you desire, download our complimentary guide, The Family Budget: Financial Empowerment at Your Fingertips.
This educational article does not offer or constitute – and should not be relied upon — as financial or credit/debt counseling advice. Your unique needs, goals and circumstances require and deserve the individualized attention of your own financial, legal, tax, and credit counseling professionals as applicable, whose advice and services will prevail. Equitable Advisors, LLC and its associates and affiliates do not provide tax, legal, or credit/debt counseling-related advice or services.