Published on October 17th, 2014 | by Pete2
Are Your Credit Cards Pushing You Into A Debt Crisis?
Credit card debt is a lot more than just what’s on your cards and the interest you’re paying. Sadly, most people aren’t aware of this. Instead, they focus on their debts from an individual perspective, attempting to manage the needs of each creditor independently of the others. This usually doesn’t work, and instead creates an added layer of worry over competing debts and how to pay them. That worry then distracts these people from focusing on their overall financial health picture.
For instance, many people struggle to make all of their monthly payments, barely stretching their income to cover car loans, credit card debt, and mortgage or rent payments. They don’t realise that they’re in, or about to be in a debt crisis, because they make their payments on time, while still managing to visit the pub or order take-out. Others make their payments, but their combined yearly expenditures are more than their actual after tax income. They don’t realise that they’re caught in a whirlpool that has the power to suck them down and financially ruin them.
Why is this pattern of spending such a problem?
Any time you spend more than you earn, it’s a problem. The fact that you can borrow money you don’t have with credit cards seems great, but it isn’t. Using that money to cover gaps in what you’re spending is a quick fix, but it’s not without cost. Every time you borrow to cover an expense, you’re increasing your debt to income ratio. When you do this, it’s chipping away at your total usable income. So a £70,000 a year salary might get chewed down to £60,000 a year of usable income after interest payments are accounted for.
When that happens, you need to borrow more money to make up for the £10,000 in interest you’ve effectively lost, which further increases your debt. After a while your finances end up looking like a boat with a hole in it. Every time you borrow more money to bail yourself out, the income you’re using to cover the bail out gets smaller and smaller. Eventually you’re trying to bail yourself out with a teacup instead of a bucket. Your boat goes under water, and your finances are sunk. That’s when you lose everything, and set yourself back the five to ten years it will take you to financially recover.
This is why credit cards are so bad. If you read over this article on managing credit card debt wisely, you should at least get an idea of what you can do to manage credit card debt. However, if you’re already almost under water, or sinking fast, it might be too late to manage the debt. You may need to consider other alternatives to save yourself before you go completely under water.
How to keep from drowning in in a credit card debt crisis?
The first thing you have to do is stop borrowing. Any time you are in debt, you should not borrow more to fix it. To give you an example, imagine you are driving down the road, and the police signal you to stop. You can either stop, or you can drive faster. If you drive faster, more police come, and you have a bigger problem. Eventually you end up featured in the Daily Mail for all the wrong reasons (are there ever any right reasons to be in the Daily?), and probably get to spend a little time in jail too.
Borrowing from credit cards work exactly the same way. As soon as you realise you’re being chased by debt, the best thing you can do is stop. The worst thing you can do is to borrow more to escape the debt that’s chasing you. Unfortunately, most people do exactly that, which is why they end up in a debt crisis. To prevent this, take these steps:
1. Log into your bank account, and set up recurring payments for the minimum amount you need to pay to each of your cards. Make sure you set the amount high enough to avoid missing any payments or actually adding to the debt. You want to keep all credit card balances at a net sero increase for the next month.
2. Next, go online, and cancel any online payments or recurring bills you have associated with those credit cards. Instead, associate them with your bank accounts.
3. Then take all of your credit cards and cut them up, or better, invite some friends over and burn them. You can always get a replacement card, but without having the physical cards, you won’t be tempted to use them.
4. Cancel any plans you have that don’t include free food and drink. Don’t spend anything other than what you’d need to spend on regular food costs. Also, if you shop at Waitrose, at a minimum, switch to Tesco.
5. Cancel any recurring subscriptions you have, such as magasines, or on demand movies. You don’t need these things to live, and if your finances crash, you won’t be able to afford them anyway.
6. Calculate all of your essential expenses. This includes rent, utilities, food, and transportation. Nothing else is essential, unless you’re receiving life saving medical treatments. That means no visits to pubs and salons until your finances are back in order. Subtract this amount from what you earn each month. This is how much extra you have to spend on your debt, and any non-essential items. If you’re in the red, proceed to step 8.
7. Now calculate all of your non-essential expenses. This would include your cell phone, morning latte, tickets to the game, or that new album you’ve been eying lately. Now calculate this amount. This is how much you are overspending. Depending on your circumstances you might need to keep an item or two in there, but as a general rule, you can cut most of it out completely. Now you know how much money you were wasting each month, that you could have been saving or putting to better use. It’s why you were in debt, drowned under a deluge of 1,000 lattes.
8. If you were in the red on your finances in step 6 above, then you are officially in a debt crisis. You will not be able to get out of this debt without the assistance of a debt counsellor, or taking some extreme measures of your own. That is a topic for another article though.
Keep in mind that if you got yourself in over your head, there are many ways you can get out. Not all of them end in financial ruin, but there are no pubs, salons, or lattes on the road to financial recovery.
Talk to a debt counsellor where you can get some free advice, and then talk to a few more. When you have a good idea of what to do, use our other guides, and put together a plan to get yourself back on dry ground. It takes work, but the end result is that in a few years you’ll have sterling credit, instead of the best case alternative of just starting to rebuild your finances years after going under.