Managing your debt

Managing your debt

The scope of the threat of credit card debt

If you found out that you've got a negative net worth, you should be concerned, but don't get alarmed yet. If you've got a negative net worth because of a long-term investment like a student loan, don't sweat it if you've got a good job.

But if you have a negative net worth because of credit card loans, you've got a problem.

There aren't many certainties in financial planning, but you can count on one thing. You'll never get off the financial treadmill if you're always carrying a balance on your credit card.

I'm always amazed when I hear that 65 percent of Americans carry a balance on their credit cards, with the average balance of over $1,900. I'm even more amazed when I hear that most Americans pay interest rates of over 16 percent on this debt.

This is too much! You won't get anywhere borrowing from your future income like this.

Good and bad uses for credit

Don't get me wrong. Credit has its uses. You can use credit to make investments, like a home or an education, or you can use credit to buy durables, like a refrigerator. These are two good uses of credit.

But if you use credit to buy perishables like vacations or clothes you're making a big mistake.

To maintain your ability to use credit for good reasons, make sure to check your credit report. The three main credit rating services in the US are Equifax, TRW and Trans Union.

If you're ever denied credit, you're entitled to have a free look at your credit report. You also can get a credit report for free or at a nominal cost if you contact these firms, and I'd suggest you do this every year. It's likely that your credit report will contain errors like listing a credit card that you've already canceled.

But what do you do if you're already maxed out on credit? And what are some signs that you're already in over your head?

Signs that you owe too much on your credit card

First I'd say if you have any kind of balance on your credit cards you're already in trouble. This may be extreme, but a third of Americans manage to pay off their credit cards each month. These people are using credit cards to their advantage, not the other way around.

Of course, bad things happen, and sometimes you have to carry a balance. There's nothing wrong with carrying a balance for a month or two if you need to pay for an emergency car repair or travel, but for anything more than this credit cards are too expensive.

How to get rid of credit card debt

If you want to buy something, there are other, better ways to get it. The best way is to do the unconventional -- save first and buy later. This may sound un-American, but it's the best way.

There are also other, cheaper ways to borrow money. Credit cards are expensive because they provide unsecured debt. The card companies have to charge high interest rates on their loans because if you go bankrupt, they lose almost everything they loaned to you. There's no collateral for their loans.

But if you use a secured loan, your interest rate will be lower. In this case you pledge some of your assets, like your home equity or an automobile, as collateral. If you can't pay up, the lender can seize your property.

Having your asset seized isn't attractive, but as long as you keep up your payments, you should be able to borrow through a secured loan and save a lot of money compared with credit card debt.

How to tell if you're really over-extended

But how do you know if you're really in over your head with debt? In that case, you probably don't need me to tell you. You're probably borrowing from Peter to pay off Paul, and you're already receiving threatening phone calls.

But one of the first early warnings of being overextended is making minimum payments. If you pay only the indicated minimum amount when you make your monthly credit card payment, you're in trouble. You should take immediate action to dig yourself out.

When people get in trouble with credit they often think bankruptcy is the best way out. It may be the best way "out", but once you take it, you'll probably never be able to get back "in".