Society in general has been brainwashed into believing that credit card and loan debt is a necessary evil and that it’s okay to have loads of debt. Well, I am here today to dispel the myths and tell you how dumb debt really is and why some people end up staying in debt for a lifetime.
Myth #1 – Minimum monthly payments will get me out of debt fast.
This is exactly the situation that generates great profits for creditors; this is a good deal for them, but not such a good deal for you.
Here’s why; let’s assume that you have a mix of 5 various credit cards and unsecured loans with an average annual interest rate of 25%. Using such debt facilities to finance purchases totalling $25,000 at an industry average minimum payment schedule this may take you about 20-25 years to pay off, at around $525/month. That’s going to amount to anywhere from $120,000 – $152,000 to pay off the $25,000 purchases.
That’s a factor of about five times the cost of the purchase.
So to put that into perspective, buying that big screen plasma TV for $2,000 on sale may look like a great deal today but it will cost you approximately $10,000 to pay it off based on the industries average minimum monthly payment plan for credit cards.
Now you may look at those numbers and think I am exaggerating. The truth is I am not; in fact the estimate is probably conservative. Notwithstanding promotional offers at 0-5% interest that usually last only six months or so, credit card interest rates are about 15-29% and most unsecured loans carry an interest rate of 15-35%.
An annual interest rate of 25% is just an average. But I did not take into account the late fees some creditors charge if you make your monthly payment late, and the example does not take into account the rise in interest rates the creditors often charge if you fall ever so slightly behind. Over the course of many years, it’s quite easy to make a mistake a few times as times change for you.
Read the back of your credit card statement on the subject of “how we apply payments”. My statement goes in this order. 1) Interest; 2) fees; 3) cash advances; 4) purchases. That’s why it takes so long to get out of debt. So next time you look at a sale item, unless you can pay off your bill in full when your statement arrives, remember the true cost of that purchase can be about five times more then the invoice price if you are planning to pay it off by way of minimum payments only.
If you have debt but are making your minimum payments plus at least 20% more then your minimums, then congratulations, you are a small percentage of people following a debt roll up strategy. You will probably be out of debt in the next 4-7 years.
Myth #2 – Making minimum monthly payments means I have good credit.
Let me share the trick to having great credit and staying out of debt.
1) Never buy anything on credit you cannot afford to payoff in full when you get your statement;
2) Never charge more then 50% of your credit limit.
That’s how you maintain a good credit rating and stay out of debt; forget anything else you have been brainwashed to believe.
If your credit rating is important to you, then understand that making just your minimum monthly payments when you are carrying debt close to your credit limit is a bad habit. What that means is, if your limit on your credit card is $10,000 and you’re making your minimum monthly payments on a $9,000 balance, your credit score is going down.
Why you ask? First of all the balance really is not coming down anytime soon. Secondly you are a higher risk of defaulting on your payments as you approach your credit limit. Thirdly and most importantly, your total debt service ratio is going to be dangerously high which is heavily weighed when your credit score is determined.
I have seen countless clients with a R1 credit rating from making their minimum payments but an extremely low credit score in the 400-500 range simply because they owed so much debt. If you are a minimum payer and close to your limit, your credit score will go south, period.
Myth #3 – I can borrow my way out of debt
Unless you are a homeowner with sufficient equity in your home or have other unencumbered collateral to offer, there is no real way you can consolidate your debt at an interest rate lower then 10%.
The unsecured consolidation loans have no collateral so they have higher risk and can range from 25-35% interest. Run; don’t walk away from these deals.
Without home equity or other collateral, it is nearly impossible to borrow your way out of debt. This type of unsecured consolidation loan is even dumber then the original unsecured debts you had.
Myth # 4 – My credit rating is more important then getting out of debt.
People are scared of ruining their credit rating by seeking help from a debt management company. It is true; there is no form of debt management that will have an immediate positive impact on your credit rating.
In our opinion, you can rate the effect that debt termination plans will have on your credit from best to worst as follows:
1) Debt roll up strategy;
2) Debt settlement;
3) Credit counselling or a consumer proposal
Now let me ask you this. If you have a ton of debt and can’t afford the credit you have right now, what do you really need credit for? If you are drowning in debt, what are you planning to buy on credit in the next couple of years? The truth is you probably do not qualify for more credit.
It is simply amazing to see the number of people who believe that credit is more important then getting out of debt.
To be more to the point, if your house was burning down in a fire, would you really care if your Italian leather couches were getting water damage from the fire departments hoses? Credit is like that couch you can easily get more credit when you debt is gone. Debt on the other hand is a more serious threat to your financial health.
Unless you have a debt roll up strategy in place, then you should probably take a deep breath and accept the fact that you have a problem and take action to address it.
Sadly the “I am going to stick my head in the sand like an ostrich” approach is the one that most people still take. Hoping things get better is really the worst thing you can do.
If you feel it’s time to do something about your debt, and want a free debt settlement consultation then please visit our home page and request a no obligation quote.