Americans have shaved off more than $100 billion of credit card debt during the coronavirus pandemic and, as vaccines raise hopes for a more open and mobile life again, we all need a plan to keep from diving back into debt.
The categories in which spending via credit cards fell off most noticeably, according to analysis by Money.com and Morning Consult, include clothing/shoes, entertainment, gifts and home goods/furnishings. Travel, too, of course. All good stuff, much of it non-essential, as we’ve learned in lockdown.
Academics who study the messy interplay between psychology and personal finance have landed on a simple strategy that can help prevent a return to freer- spending ways: precommitment.
Hatch a plan for how you will react in the future. Write it down. Share it with family and friends. When we slow down and think through how we want to behave in the future, it helps us stay on course in the heat of the moment.
— Keep your pandemic spending habits. Make “wants” a budget item with the 50/30/20 approach. Half of your after-tax income goes toward needs (housing, food, utilities), 30% to wants and 20% is for saving/paying down debts. (If you have high-rate credit card debt, you might consider 20% on wants and 30% for saving/debt repayment.) The main point is to decide on a set amount you will spend on “wants.” No more than that.
— Decide now how you’ll use extra money. If you receive new federal stimulus funds, or a tax refund, cover essentials first, by all means. But if you already have those costs covered, make a plan for how the money will be used. There is no single “right” move. But if you already have a decent emergency fund, then using extra dollars to pay down credit card balance is wise. The average credit card charges more than 16% interest. Wiping out an unpaid balance is the equivalent of giving yourself a 16% return on your money.
Caveat: Paying down credit card debt is only effective if you simultaneously make the commitment to not run up a new balance on wants. That’s on you, though here are some spending control tips to get you started.
— Get the best deal on your existing credit card balances. If you have unpaid balances, and you have been diligent about making on-time payments (even just the minimum), ask for a lower interest rate. Way back before pandemic times (2019) a survey found that eight in 10 people who asked for a rate reduction got one, and the average drop was a sizable 6 percentage points.
If you have a strong credit score, at least 720 to 750, and your household income is steady, you might snag a balance-transfer deal and move your unpaid balances to zero interest for 15 to 18 months. These days you’ll likely pay a 3% fee on the amount transferred. But that’s still a win if it gives you time to erase debt you were paying 16% interest on. (Search “best balance transfer deals.”)
— Tackle remaining debt with a system that motivates. The best repayment strategy makes you feel so good, so in control, that it sustains your mojo.
If you have debt on multiple cards, you must pay the monthly minimum on each card. But then you’ve got choices. Financially, sending in more on the card that charges the highest interest rate will save the most money. But maybe what appeals to you is paying off one card entirely, even if it’s at a lower rate. Go for it. The key is momentum.
Side strategy: Each month your credit card recalculates the minimum payment due. It’s a fixed percentage of your outstanding balance. That means that if you are making great progress paying down your balance, your minimum monthly payment will be lower each month. That might seem like a sweet deal, but it’s actually a costly trap. By paying less you remain in debt longer, which means paying more in interest charges. Sigh. A workaround is to write down the minimum due this month for each card, and make it your goal to never pay less than that in the coming months.