There is one word that seems to trouble most people — debt.
Politicians are worrying about the national debt and how we can budget to try to reduce it. Students are going to school and being overwhelmed by debt when they graduate. Retirees are hoping they can live a debt-free retirement and be relieved of the headache that debt can bring.
Yet not all debt is necessarily bad, and there are many ways it can work to your advantage. For example, in some cases, a person may be better off mortgaging a new home and making payments to build equity in the house, rather than buying it outright. One type of debt that I believe to be very dangerous, however, is credit card debt.
You may see credit card applications coming to you in the mail with different offers and options that seem to give you a great deal. While credit cards can come in handy, there are a few things to be careful about. For one, many credit cards have very high interest rates, making credit card debt one of the worst types.
According to ValuePenguin.com, the average interest on a credit card is 14.62 percent, pretty high considering the low-interest rate environment that we are in. Let’s say that you have $10,000 in credit card debt on average at the end of the month. If you have a credit card interest rate of 15 percent APR, you would owe $150 in interest to the credit card company. This situation does not account for compounding, so please keep that in mind.
On the other hand, there are benefits to using a credit card, especially if you pay your entire bill each month and don’t accumulate interest. As you probably know, credit cards offer many different reward programs, including travel and cash-back bonuses. Say that you spent $1,000 this month using your credit card and paid it off at the end of the month. If you were to select a common cash-back rewards card, which offers 1 percent cash back on all your purchases, you would receive $10 back each month. It may not seem like much, but it can really add up depending on how much you spend. And, of course, a credit card can be used as a last resort if you are in need quick need of money and to build up credit.
As a financial adviser, it isn’t uncommon to have clients with decently large sums of credit card debt. One option to potentially reduce or eliminate your credit card debt is to refinance your home or get a home equity line of credit. These can be obtained at a local bank or credit union. Although they will be using your house as collateral, you may be able to use this loan or line of credit to pay down your credit card debt and pay substantially lower interest. Another way to pay down credit card debt is to invest less in other areas and instead put that money toward your debt. This could be a good option if you anticipate making less on your investments than what you would be paying for your credit card interest rate. There is no sense in paying 15 percent interest on credit card debt, while saving your money and only making 5 percent on your investments. The bottom line is to look at your different options and see which one works best for you.
Overall, credit cards can be a benefit to you, or they can hold you down and cost you. While credit cards can be useful, you should be careful when managing them. Don’t let the debt grow to a point that is uncontrollable. Look at different ways to manage them better and try to find ways to lower the interest that you are paying.
Hunter Larson joined D.A. Davidson in 2015 as a research associate and successfully contributed to the IIG Research Team for more than a year before accepting a position as financial adviser in Aberdeen.