Everything you should know about your credit card debt

Credit card debt is the amount of money you owe for purchases made using your credit card. Your credit card is issued with a revolving credit limit you can use without restriction. You must, however, make a minimum monthly payment to avoid interest charges. You begin to accumulate debt once you reach your limit and cannot afford to pay off your balance at your monthly due date. Your credit card debt is easier to pay off when your balance is low.

Most cards provide you with a grace period of about 20 to 30 days within which you’re allowed to make payment for purchases made before interest is charged to your account. Interest rates paid outside the grace period vary based on the bank issuer but are typically within the 19 to 30 percent range.

In addition to making purchases, you can take a cash advance with your credit card. Typically, there is no grace period for the interest accrued on your cash advance and the rate may be different from what is charged on purchases. Some credit card companies deduct a service charge for your advance, making cash advances very expensive to use.

How does credit card debt affect your credit score?

Your credit score is a three-digit number that represents your creditworthiness. Each creditor reports a rating to the credit bureau, based on the history of the account. The creditors use the ratings to determine your credit score. 

These are the factors considered when calculating your credit score:

1. Payment history. Your ability to make your payments on time accounts for 35 percent of your credit score. Questions such as ‘Do you pay in full each month?’, ‘Do you miss payments?’ and ‘How long were your bills unpaid?’ will arise.
2. Amount owed. This is a consideration of how much you owe on your account types and how much credit remains available to you.
3. Credit history. Your credit behaviour can be determined by the length of your credit accounts. The longer your history, the more responsible and less risky you’re considered to be. Having and maintaining older accounts in good standing will have a positive effect on your credit score.
4. Types of credit. Having a mix of credit cards, retail accounts, mortgage and car loans influences your credit score. Your score could be affected if you have too many credit accounts or don’t have a mix of the different types.
5. New credit. How many new accounts have you recently opened? Too many credit accounts with different lenders send the message that you’re incurring new debt, and this may negatively impact your credit score.
6. Credit card balance. Be mindful of the amount of credit you use compared to your total limit. Maintaining balances close to your credit limit will negatively impact your credit score.

How to pay off credit card debt

Paying off your credit card debt is not impossible. You can reduce or eliminate your debt completely if you create a realistic plan and stick to it. This can be achieved in two broad ways:

Self-directed repayment plans

These require you to set up a plan and commit to seeing your repayment through, all by yourself. They are hands-on approaches to successfully paying off your credit card debt.

1. Use debt consolidation: This solution may seem unreasonable given that you will have to take out a new loan or credit card to pay off all your existing credit. You pay your outstanding debt with a zero percent balance transfer credit card or personal loans which have low-interest rates. This leaves you with only one monthly payment which will be easier to manage.
2. Use the debt snowball method: Choose your credit card with the lowest balance and prioritize paying this off as quickly as possible. When it’s paid off, you roll that payment into the amount you’re contributing to paying your next lowest balance, and so on. Continue in this manner until you’ve paid all your debts in full.
3. Consider the avalanche method: Here, you prioritize the account with the highest interest rate and pay that off first. When it’s paid in full, select the account with the next highest interest rate, and so on. This method is usually faster and cheaper. 

Debt relief options

With these, you’d have to engage the services of professionals who would work with you develop a more serious plan to repay your debt.

1. Use a Debt Management Plan (DMP): This involves engaging a debt management company to analyze your debt situation and find the right solution for you. If necessary, they negotiate with your creditors and arrange a single payment through the debt management company to your creditors. Generally, DMPs do not reduce the principal amount owed and there are no formal processes to stop collections or creditor actions.
2. File a Consumer Proposal: This involves finding a Licensed Insolvency Trustee, such as MNP Ltd., who are licensed by the federal government. The Trustee will help determine how much of your debt you can afford to pay. A Consumer Proposal is usually less costly than a DMP and creditors cannot opt out of it.
3. File bankruptcy: This also involves finding a Licensed Insolvency Trustee. A personal bankruptcy will affect you more negatively than a Consumer Proposal but may be suitable if you can’t afford to pay a portion of your debt.

Avoiding credit card debt is possible and it starts with spending wisely and saving smartly.