Understanding Your Credit Card & Other Debt

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Originally published in 2011 and updated in May 2021

Credit Card usage in the U.S. has traditionally been very high. Recent trends (2011) tend to show that Americans are paying their credit card debt in a more timely and effective manner than in the past.

Even so, many do not understand how credit cards work.

In this discussion we will look at credit cards and how they work, provide you with possible solutions to pay your credit card debt off in a more timely and effective manner, provide you with helpful advice if you want to pay your mortgage off early and conclude with our final thoughts on credit and other debt.

GRACE PERIOD:

With all credit card agreements you would have a” grace period” where if you make a timely payment no interest is charged. If the payment is not received during the grace period you would be charged “interest” for the use of credit.

Also, if you travel abroad or make purchases outside the U.S. you normally would have a foreign transaction fee of 1% or more with most card issuers. Use caution with cash advances as they normally have high fees and the interest runs from the day of the advance until the date you pay the creditor back.

If you make a charge with your credit card make it a habit to pay off the balance in full during the grace period. Doing so will keep your finances at a manageable level and help improve your credit and credit score at the same time.

BILLING CYCLE:

In many cases interest is calculated based on the billing cycle. Many creditors add any new transactions, interest, fees, and other charges to your balance and subtract any payments or credits—they normally would not add new purchases if a grace period applies.

They then add the daily balances from the billing cycle and divide by the sum of the days in the billing cycle which would give them the average daily balance which would be multiplied by the interest rate.

The interest would then be added to the balance. The average daily balance is normally what is subject to a finance charge.

Let’s say you purchase a washer and dryer for $900 in June of 2011. If you paid the balance off in July you would pay no interest. If, however you paid $100 in July your average daily balance for July would be $800 and the interest would be calculated off that for your August payment.

Let’s say you have a 30 day billing cycle. Daily balance in billing cycle: $800 * 30 = $24,000

Sum of the days in the billing cycle: 30

Average daily balance: $24,000/30 = $800

Interest Rate: 14.99%

Average daily balance multiplied by the interest rate: $800 * 14.99% = $119.92/12 = $9.99

Add interest to the balance: $800 plus $9.99 = $809.99

Your August balance would be $809.99 and if you paid $109.99 and made no other charges your September balance would be (average daily balance of $700 * 14.99%) $708.74.

BALANCE TRANSFER:

If you had good credit and wanted to transfer high interest rate balances from other cards to a new account you would normally have a balance transfer fee which is normally 3% or so with many credit card issuers (i.e. $10,000 transfer @ 3% would be $300).

If you transferred that balance at zero percent for 18 months and had a well thought out payoff plan you could still come out ahead.

Let’s say you were paying interest on the $10,000 at 14.99% you would be paying over $100 per month in interest alone. In three months you would have recouped the $300 and would be in position to pay the remainder of the debt off in 15 months at zero percent interest.

If you had the right income and discipline you could pay $650 or so a month for 15 months and be credit card debt free.

By doing so you would save over $1,500 in interest and put yourself and your family in a better financial position!

If you transferred to an account that did not have a zero percent interest rate promotion you would normally pay interest from the date the balance transfer was processed until the balance was paid off.

If the rate was at a substantially lower rate than you were paying with your previous credit card company you could still come out ahead but it would not be as dramatic—you basically have to run the numbers on the front end to see if it would make good financial sense and would be worth the hassle of changing—or pursuing other options.

Always remember that with many credit card issuers Cash Advances and Balance Transfers do not have any grace period. 

Cardholder Options:

Sole Applicant

If your name only appears on the bill you are the cardholder and you would be responsible for the account balances.

Failure to pay or paying in an untimely fashion would negatively affect your credit only.

Paying in a timely manner would have a positive effect on your credit only. As a sole applicant you would be issued a card in your name only and it would be your account only.

Joint or Co-Applicant

If your name and that of a co-applicant appear on the bill, you would each be jointly and severally liable for the account balances.

Failure to pay or paying in an untimely fashion would negatively affect your credit and the co-applicants credit. Likewise if the co-applicant failed to pay or paid in an untimely fashion your credit would be negatively affected.

If you have a co-applicant cardholder you must ensure that timely payments are being made in order to have a positive effect on your credit. A co-applicant would be issued a card in their name and you would both have the same account number.

Authorized User

In this scenario, you the cardholder granted authority to use your credit card account. If you granted authority to another for the card usage you would be responsible just as mentioned above as a sole applicant.

Timely and untimely payment would primarily affect you, but could also have an effect on the authorized user’s credit.

Your creditor would normally not attempt to collect from an authorized user unless you (the cardholder) refused or failed to pay the card issuer!

An authorized user would be issued a credit card in their name with your account number if you designated them based on card issuer policy.

With some companies the fact that you allowed another to use your credit card creates an authorized user.

Other User

If you allow anyone to use your credit card other than a cardholder or authorized user you would be liable to the credit card issuer.

Reward Cards

Many credit card issuer's offer rewards for the use of their credit cards under certain conditions. In many cases there is an annual fee or a pre-determined dollar limit that you must charge in order to get the rewards.

At our office we are not big fans of reward cards for those who are in the process of improving their credit as we feel a strategy of properly establishing an emergency fund and paying off or paying down your credit balances are a better short-term strategy for most.

Although it may appear that you are getting a reward—or something for nothing—that is usually not the case if you do not manage your credit optimally.

By paying credit card interest at 15% or more, you are in many cases subsidizing your own "so called rewards" and you should not be involved in a rewards plan unless you can actually come out ahead—and you have strong self-discipline.

You can come out ahead by comparing the annual fee and rewards and your credit usage and payment habits to see if it is to your advantage.

To reduce your financial and life stress we feel the establishment of an emergency fund and the payoff of your credit card balance on a monthly basis is a better strategy in the short-term.

Be sure to find a credit card that offers you the lowest rate based on your credit profile if you are in the unfortunate position where you must carry a balance.

For those who do not carry a balance you want a card with no annual fee—and because you are in position to pay the balance off monthly the interest rate should not be your primary concern!

In addition, if you do not carry a balance and have address your credit and overall finances appropriately, a reward card or two may be ideal for you.

However, you should still look for the best rate based on your credit score if you plan on getting a new card to maintain or improve your credit. 

Credit Cards:

Many financial planners and other professionals use emotionally charged debt payoff names when articulating their debt payoff plan as if there is a magic bullet or secret formula to paying off your debt.

When it comes to paying of your debt—there really is no magic bullet or secret formula!

The Key Is...

• Your determination and eagerness to pay off your debt.

• Having the right amount of income to pay off your debt.

• Having a workable plan (written) to pay off your debt.

*If there were such a "magic bullet" or "secret formula" it would be your "level of determination to aggressively pay off your debt" along with "motivational factors that inspire you to pay off your debt" so that you can achieve the goals that are most significant to you and your family!

Options for those who have Credit Card Debt:

Pay off from the lowest balance to the highest balance:

If you have credit card debt with three card issuers of $400—minimum payment $10, $1,200—minimum payment $20 and $4,800—minimum payment $100 and have adequate income (monthly discretionary income of $200) you could choose to pay off the $400 credit card balance in two months and make the minimum payment on the other two.

After the $400 credit balance is paid off you could include the $200 payment along with the minimum payment and pay the $1,200 credit card balance in roughly 5 months.

After the $1,200 credit card balance is paid off you would take the $200 plus the two minimum payments from the $400 and $1,200 credit balances (total of $320) and apply towards the $4,800 balance and in approximately 14 months the balance would be paid off.

Total payoff time would be 21 months for all three credit cards.

Pay off from the highest interest rate to the lowest interest rate:

The $4,800 credit card balance account has a rate of 18.99% and the $400 credit card account has a 6.99% rate and the $1,200 credit card balance has a zero percent interest rate for the next eighteen months. Again your monthly discretionary income is $200.

You pay $300 per month and in 16 months or less you would have a zero balance on the credit card balance of $4,800. By making the minimum payment of $10 on the $400 credit card balance for 16 months you would have a balance of about $300. You would then pay that balance off.

At that point you would have a balance of approximately $860 on the $1,200 credit card balance and would pay the majority of it off with no interest—the interest you would pay would be minimal.

Total payoff time of approximately 19 months.

Mixed Bag Approach:

A random approach that is often used by those trying to pay off their debt and they know no other way.

Although the approach may not make the most financial sense and may lack clarity—you may pay more in interest and/or have a longer payoff period it can still get you out of debt.

I have seen this approach used successfully by those who were truly motivated to pay off their debt and that was the best approach that they came up with at the time.

The key with any approach to debt payoff is having the right amount of motivation and adequate income!

Pay-off and save at the same time:

Again if you had $200 in discretionary income and you were to pay off your credit card debt in the manner listed above—but decrease your payment from $200 to $150 and save $50 per month.

Your payoff time would increase and you would pay more in interest. However, you would have savings of over $1,200 dollars with payoff times of 25 months or so using the scenarios above.

Keep in mind that it is not your approach but your "level of determination or motivation and income" that is the real key to eliminating debt. 

Transfer credit card balance to a zero rate card:

If you had good credit and were to transfer the balances on all three cards ($400, $1,200 and $4,800 = $6,400) to one card with a zero percent interest rate for 18 months you would more than likely have a 3% transaction fee ($6,400 * 3% = $192) at the time of transfer to the new account which would take your account balance to $6,592.

Your minimum payments of $10, $20, and $100 total $130. You discretionary income totals $200. You combine the two ($330) and make payments for roughly 20 months and you would eliminate all of your credit card debt.

Keep in mind that there are other payoff methods available.

Ranking your debts based on your current balance and minimum payment will give you a debt payoff method that will get you moving fast.

You will see payoff results in a short period of time. Many clients choose this method because they build positive momentum quickly.

Mortgage Loan Payoff:

If you have all areas of your finances addressed properly—and you carry no revolving or installment debt other than your mortgage—you might be tempted to pay your mortgage off early.

Those with high discretionary income and no debt often refinance to a shorter term, or pay off their mortgage more aggressively with their discretionary income.

After their mortgage is paid off they have more income that they can use for the enjoyments of life or additional savings and investments.

Once you pay off your credit card and other debt and address all of your insurance, investment, taxes. educational needs, emergency fund, estate planning/wills and retirement planning needs—you could possibly be in great position to pay your mortgage off now or pay the mortgage off in a more aggressive manner.

If you are in a strong financial position and have adequately addressed all areas of your finances the early payoff of your mortgage should be given strong consideration.

In many cases the tax benefit will be more than offset by you having true ownership—and the peace of mind and flexibility that true home ownership offers.

Bi-Weekly Mortgages

If your lender offers bi-weekly mortgage payments at no charge and there are no set-up or annual fees you might want to consider the option.

In most cases a bi-weekly mortgage is offered by third-party and other outside operators for a fee and/or annual charge.

A better approach if your goal is to reduce the term of the note may be to make an additional payment(s) annually or add 1/12 of your monthly payment (or a higher amount) to your monthly payment for 12 months—be sure to designate the additional amount as principal payment.

Final Thoughts On Understanding Your Credit

The point of this discussion is that there are a number of ways of paying off your debt.

The more aggressively you attack your debt the sooner the payoff and the less interest you will pay.

The right approach for you—may be the one that works best for you and your family!

It may be wise to increase your income—if only for a temporary basis during the payoff period (such as work a part-time job—work overtime etcetera) and definitely stop the use of your credit cards.

It is also wise to consider other ways that you can cut expenses or save on spending.

Doing so will put you back on track to taking control of your finances—or put you on track if you have never managed your finances effectively before.

Also, keep in mind that various credit card issuers have there own system for granting credit and credit card agreements vary.

What has been discussed in this article are some of the common features that can be found in many of the credit issuers that our company has come across on a frequent basis over the years.

By putting together a written plan that you mentally formulated and believed in—you put in motion the foundation for improving your credit and finances in a major way.

By adhering to and accomplishing your debt payoff goals you will be in position to benefit yourself and your family in a positive way for years to come!

Also, after you eliminate your debt—be sure not to repeat the cycle.

Pay your credit card balances off in full on a monthly basis if at all possible!

Build your credit and emergency fund and start on the path to addressing all areas of your finances in an appropriate manner.

By doing so you will take back control of your finances—and your life! 

All the best to your credit payoff success...

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