Consumer debt are loans used for personal consumption such as buying a car or more generally a depreciating asset (any item which starts losing value the minute you take it out of the store). Credit cards, personal lines of credit and auto loans are common examples of consumer debt. In this post, I am going to focus specifically on how to train yourself on minimizing the amount of debt you take on an eliminate your credit card debt as it is the most common.
Beware of influences that affect your buying decisions
When it comes to consumer debt, the best course of action is to avoid it in the first place. I do realize that it is simply stating the obvious. However, sometimes that is not possible all the time. A classic case is purchasing a car. Most people cannot fork up a wad of cash to buy a car or go about without one. This is especially true for millennials and Gen Z in their formative years.
If you read my earlier post on getting rid of debt slavery, I pressed on the need to master the Diderot effect – the tendency to overspend based on a fictitious need. When it comes to buying a big-ticket item such as a car, it is well-known fact that a used car is far more cheaper than a new car. A new car loses as much as 30% of its value from the time you drive it off the parking lot to your home! However, despite being well-aware about this hard fact, most people still prefer to buy a new car. The reason for that is most buyers perceive the new car to be problem-free and a user car to be problematic (I do not want to get stranded on the freeway!!).
Do not exaggerate the risk
The above example is a classic case of risk exaggeration – the buyer is unable to decisively evaluate the risk and therefore makes a purchase that costs significantly higher. The perceived benefit (the car not breaking down on the freeway) is not that much. In simple terms, the extra cost is not worth the reward. Car salespeople are very well aware of this tactic and often blow up the risk to convince the customer to buy a new car. A simple solution is to educate yourself on how to assess the condition of a used car.
One of the most simplest ways to manage your consumer debt is to understand the risk and not exaggerate it. While I gave the example of buying a car, there are many situations in which you can save significant sums of money if you take the time to truly understand the risk. Do you really need the extended warranty on the new vacuum cleaner? Do you really need travel insurance on your trip to the Bahamas?
Get a handle on credit card debt
Out of all the different types of consumer debt, credit card debt is the worst as most lending institutions will charge anywhere between 10-20% on the outstanding balance. It is also the most infectious, as the availability of one-click shopping has made racking up debt super easy. Furthermore, when you reach your credit limit, banks are likely to raise it even further, allowing you to drown even more! Makes sense for them – the more you owe, the more money they make.
Here are some of the steps you can take:
Make minimum monthly payments: First of all, make sure that you pay the minimum monthly payment on all your cards to make sure that you don’t go into default.
Tackle the worst ones first: Take all the savings that you can gather and direct the maximum firepower at the card with the highest interest rate first. Some people recommend to go after the smallest loans first to get a boost of self-esteem. My advice is not to do that as stopping the blood-letting, aka interest expenses, as early as possible is the most effective approach.
Consider re-financing: It might seem odd to apply for a credit card when your goal is to eliminate debt. However, several companies offer 0% balance transfer cards can help you save you money in the long run. Find a card that offers a long 0% introductory period — preferably 12 months or more — and transfer all of your outstanding credit card debt to that one account. You’ll have one simple payment each month, and you won’t pay interest. This is a very good option but there are certain pitfalls you must be beware of:
a. Before you do that, make sure that you can keep yourself disciplined enough to pay off the balance within the grace period. A lot of these promotions are designed with the intent that you will not be able to make the payments, which will then result in sky-rocketing interest rates!
b. Make sure to read and re-read the fine print. Don’t just run with the headline offer. Make sure you fully understand what you are getting yourself into by verifying that there are no hidden clauses and you are truly gaining by making the transfer. For example, some 0% cards will give you 60 days or so to make the balance transfer after you sign the paperwork. However, if you take the full 60 days to make the transfer then that time is deducted from your grace period. In other words, the fine print might say that the grace period begins from the day the paperwork is signed.
Pick up the phone and talk: The power of a down-to-earth, honest conversation is huge. Don’t underestimate that. Reach out to your creditors, explain your situation and try to negotiate for a grace period or a lower interest rate. There is a lot of competition among companies and most of them are more than willing to work with a long-term customer who have not missed payments. Also, most companies will not admit it but it is much more profitable to make money through customers themselves making regular payments rather than recovering funds through debt collection agencies (who in the best of circumstances will only recover a partial amount and keep their own cut as well).
Personally, I would recommend pursuing the third and fourth options in tandem and then moving forward with the best one which gives you the most value.
That’s about it.