By Ruth Mahoney, President, Capital Region, KeyBank
Last week, the Federal Reserve raised short-term interest rates by a quarter point—putting it to 2 percent. It is the second of four expected increases in 2018, and for borrowers, it means the cost of borrowing has become more expensive.
While an increase in the interest rate will benefit those with savings, it adversely impacts those with adjusted rate loans and credit cards, which are generally tied to the prime rate. For example, according to Bankrate.com, the average variable rate for credit cards is 17 percent. If you carry the average U.S. household credit card debt of $16,000, the quarter-point hike will likely translate to an additional $40 a month in interest.
It’s no surprise then that people with high credit card balances are concerned about feeling a personal finance pinch. The pinch is real. Higher rates are here, and not only are they here, but they are here to stay—and forecasted to climb higher.
However, the situation is far from bleak for credit card holders. Smart use of credit has long been and continues to be a great tool for managing finances, boosting borrowing power and growing wealth…provided you manage credit responsibly.
Attack your credit card debt
The important thing to realize about dealing with credit card debt is that there are options. There is no such thing as a one-size-fits-all solution. That said, a good place to begin is with a divide and conquer approach.
Separate your existing credit card accounts into three categories by balance and interest rate:
- High balance/high interest
- Low balance/high interest
- Low balance/lower interest
Your banker can be a great resource for talking about borrowing options, such as interest-free balance transfer cards, unsecured personal loans and, if you own your home, home equity loans and lines of credit.
If you have moderate debt (low balance/high interest) transferring your balances to a single card can be a good option. There are a number of interest-free balance introductory cards available. Just be sure to consider balance transfer fees, as most transfer cards assess a fee per amount transferred. Then commit to paying off the new card within the promotional rate period.
For those carrying larger debts, a personal loan can provide you with a fixed interest rate and fixed monthly payment over a fixed period of time.
Finally, if you have available equity in your home, a home equity loan or line of credit may be a good option for consolidating your debt. Home equity loans and lines of credit typically have rates lower than most credit cards.
Work with your banker to rank your options by loan term, payments and interest savings so you have a complete picture how each option affects your short-term and long-term plans.
Be smart with your credit card use
Like any good habit, smart credit card use doesn’t end with a plan to consolidate and reduce card debt. The following suggestions can help ensure you keep moving forward and improving your financial wellness.
- Keep all credit card utilization—meaning the percentage of credit used—at 30 to 40 percent.
- Know your spending habits and set a credit card spending spending limit. You can use spending and security alert options to help you stick to the limit.
- Pay cards off in full each month, or pay extra each month.
Also, consider having two credit cards. One card should feature a revolving balance for major purchases. The other card should feature a rewards option that is appropriate for your lifestyle. Use that card for regular purchases and reap the rewards, such as cash back or gift cards.
There’s immediate gratification—and budget relief—to be had by paying off high interest credit cards. However, it is important to avoid falling into old habits.
For starters, make the next step in boosting your financial wellness by moving from saving on interest to bolstering saving. Take the money you were using to make debt payments and use automatic savings account options to deposit money into an emergency savings account or money market account.
Finally, take your savings to the next level. You know how much more money you will have once you’ve paid off the no-interest introductory card or the low-interest term loan. Use that estimate, and develop a savings strategy for the future.
Regardless of what happens with interest rates over the next six months and beyond, dividing and conquering your credit card debt allows you to take better control of your finances.
Remember, most people struggle with debt at some point in their lives. It is not insurmountable, and getting back onto the path of financial wellness may not be as difficult as it seems. You just need to take a step in the right direction. A frank, goals-oriented conversation with your banker is a good place to start.
About the author: Ruth Mahoney is regional retail leader and president of KeyBank’s Capital Region. She may be reached at either 518-257-8619 or [email protected]
Pay on time and pay it down to boost your credit score
If you’ve ever made a major purchase, such as buying a home or car, you know your credit score is one of the most important considerations for lenders. Your credit score helps lenders predict your potential credit risk. The better your credit score, the lower your cost of borrowing money. It’s that simple.
While the most heavily weighted factor in determining your credit score is your history of paying bills on time, another critical component is demonstrating that you can manage debt.
Here’s what you need to know about each.
Payment history. According to MyFico, bill payment history accounts for 35 percent of a FICO score. Considerations include: accounts from major card issuers, retail store accounts, installment loans, finance company accounts and mortgage loans.
To ensure you don’t miss any payments, which can significantly dent a healthy credit score, put all your payment due dates in your calendar. Also, where practical and applicable, set up automatic payment for your bills. You can use bill pay to schedule and keep track of payments.
If you know you’re going to have difficulty paying your bills, talk to your creditors about hardship programs. You may be able to adjust due dates, reduce interest rates or have certain fees waived. Just don’t wait until you are already behind in payments.
Debt-to-credit ratio. While you want to slash your overall debt load as much as possible, revolving credit, such as credit cards, should be your priority. Revolving credit is debt with a defined limit that you can continually access over time. Credit scores reflect the amount of available credit you have versus the amount of credit you are using. Ideally, you want to use less than 30 percent of your credit limit.
It’s important to note that amount owed is not as important as the percentage of credit you are using. Also, amount owed is not strictly limited to your debt-to-credit ratio. Other factors include the total number of credit accounts you hold, how many have balances, what those balances are and the amount owed relative to the original balance.
Installment loans, such as mortgages, student loans and auto loans are treated differently than revolving credit. Paying them down will help lift your credit score, but carrying a large balance on such loans has minimal impact. Just make sure you pay on time—always.