Credit card debt is one of those things that can sneak up on you when you least expect it.
It’s lurking behind that balance transfer credit card that’s begging you to use it for new purchases. It hangs out in dark alleys and tells you to take a vacation you can’t afford to earn a sign-up bonus. If not, you’ll lose free money!
I’ve been thinking a lot about debt because, according to the Federal Reserve, revolving debt (this includes credit cards) increased by 1.5 percent in July. This means that consumer revolving debt now stands at $1.037 trillion.
You can avoid being part of this trend by recognizing situations that can lead you down the path to debt. Let’s take a look at four ways debt can catch you by surprise.
You Take Advantage of Your Credit Card’s Rewards Program Without Reading the Fine Print
It’s so easy to get lulled into fantasy land when you feel the need for the beach and the sound of the ocean. There’s nothing wrong with using your rewards card if you have the money to pay off the balance when you get back home.
But there are some rewards programs that don’t look like they’re debt traps. For instance, American Express has a Fly Now, Earn Later program. You can take the trip of your dreams even though you don’t have the miles saved up to pay for the ticket.
OK, you’re basically buying a ticket on credit that you have to pay for within the next six months. For savvy consumers, this might not be a problem. You know you’ll spend enough with the card to earn the miles before it’s time to pay the bill.
But what if things don’t work out that way? If you haven’t earned the miles within six months, you’ll get charged for them at 2.5 cents per mile. At, say, 10,000 miles short, that’s $250. The annual percentage rate for this charge will be the same as your purchase APR.
If you can pull this off without losing a dime, then more power to you. But I don’t think it’s ever a good idea to take a trip now and pay for it later. You just don’t know what will happen between now and later.
If it’s an emergency, such as a death in the family, and you can’t afford the ticket today, then that’s an acceptable reason. And even then, when you get home, focus on earning those miles back within six months.
The next one is also travel-related, but involves installment payments.
You Decide to Make Payments (With Interest) on a Trip You’ll Take Later
In a similar vein as No. 1, there are websites that will gladly take your money to finance your trip. For example, Flightlayaway.com allows you to use a credit card to pay for a ticket by making installment payments at 15 percent interest. And there’s also a 15 percent booking fee.
There are many others, including UpLift, which partners with some major airlines, including American, JetBlue and United.
The site states that APRs are as low as 9.01 percent. If you have credit problems, you’ll get a much higher rate than this. Keep in mind that interest starts accruing as soon as the loan is originated. Oh, there’s an origination fee, too.
If you’re using your credit card to make the installment payments, then you’re using credit to pay for credit. Keep in mind that you have to pay back the credit card issuer for the monthly installment payment amount. And if something happens and you can’t pay the bill in full during the grace period, then you’ve got to also deal with interest on your balance.
This approach is complicated and more expensive than necessary. Why not just put those funds in a special vacation account with your bank or with a high-yield online savings account? If you’re determined to use credit, then use a credit card that offers a zero percent APR on purchases for 12 to 18 months.
You Don’t Know That Universal Default Still Exists
Many consumers thought this practice was eliminated by the Credit Card Accountability Responsibility and Disclosure Act of 2009. The CARD Act placed some limits on universal default, but it can still happen under a specific set of circumstances.
Universal default, in general, means that a company can change the terms of your credit card if you’re late on a payment. This might include applying the default APR or reducing your credit limit.
Neither one is good for your credit score or for your wallet, but the scary part of this is that your new 29.99 percent APR can be applied to your outstanding balance.
If you’re more than 60 days late on a payment, the issuer can legally apply the penalty rate to your entire balance. There is a provision in place that requires the issuer to adjust your APR after you’ve made six on-time payments. Don’t expect your card issuer to track this and automatically lower your APR. Stay on top of it and make sure it happens.
You Decide to Get a Payday Loan Just Once to Get Caught Up
If you still have great credit and your solution is to transfer debt to a balance transfer credit card with a zero percent introductory APR, that’s a reasonable decision. Well, with one caveat: You must never use your new balance transfer card for new purchases. Adding to your already bloated balance will put you in more debt.
The same advice goes for debt consolidation loans. You have to stick to the plan, which is to get yourself out of debt while saving on interest.
You know what can happen just when you think you’ve got control of things? You get a little too relaxed with spending. You tell yourself you can put a new high-definition TV on your balance transfer card because the card also offers a zero percent purchase APR.
Before you know it, you’re having trouble making the minimum monthly payments. As the debt grows and the intro rate ends, you start having trouble covering your everyday expenses.
This is when payday loans look attractive. You can get a short-term — but high-cost — $500 loan. You might think that you’ll only do this one time just to get back on track. But getting that first payday loan is a sure-fire way to dig yourself into an even deeper hole.
According to the Consumer Financial Protection Bureau, 80 percent of payday loans are rolled over or followed by another loan within 14 days. The due date to repay the loan is usually only a few weeks away, so it’s easy to fall into the “just one more time” trap.
A common two-week payday loan has an APR of almost 400 percent, the CFPB says. For example, a typical loan has a $15 fee for each $100 borrowed. Getting a payday loan can be one of the worst financial decisions you’ll ever make.
If things get so bad that those terms look acceptable to you, then consider reaching out for help. You can find an accredited credit counseling agency through the National Foundation for Credit Counseling. You’ll get a free phone session, in most cases, to help you know your options.
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