How to Get Out and Stay Out of Debt
Part 2–So Did You Cut Up Your Credit Cards?
Most people assume that the first thing I did when I decided to take the bull by the horns and get out of debt was to cut up my credit cards.
Well actually, huh… no. I can’t even say it crossed my mind. Instead, I thought I should take advantage of the fact that, through years of creatively taking from Paul to pay Peter but never getting ahead, I had built an excellent credit rating for myself that would help me get out of debt. Besides that, I’ve never been much of a compulsive shopper, so I wasn’t a danger to myself with a credit card.
So, I kept the cards and, more importantly, my line of credit. In fact, the latter was the centrepiece of my debt-elimination scheme. While I was lucky that I had the low-interest option on my main VISA — about 10 to 11 percent interest annually instead of the more standard 18 to 19 percent — the rate I had on my line of credit (LoC) at the time was even better — about 4.5 percent annually — plus, by that time, I had a pretty high limit (about $35K if I remember correctly).
I handled my LoC as “just another bank account” except that it works in reverse in that a positive number means that I owe that amount rather than have it. Therefore, my first step even before I started my serious number crunching was to take each outstanding balance on the credit cards and move it to this so-called account. In so doing, I self-consolidated my debt.
In Canada, a line of credit is like an open loan that’s always accessible to you. You don’t have to use any of it and if you don’t, it doesn’t cost you anything to have it. However, it’s money you have access to at a far lower annual interest rate than a credit card.
Every month you pay the interest on that balance, but instead of that amount being added to the outstanding balance (as is the case with credit cards, which is what gets you in trouble with them), it is taken directly from the chequing account to which your LoC is linked. The moment you pay off a bit of what you owe, you start paying the interest only on the new outstanding balance. A LoC can be recalled at any time but, in my experience, as long as the bank always gets its monthly interest from you, it’ll be happy (because it’s making money off you) and you’ll be happy (because you’re not letting the bank make AS MUCH money off you).
The balance on my LoC has been at zero for three years except for a 10-day period last year when I borrowed against it to meet the 2014 contribution deadline for my registered retirement savings plan (RRSP). I knew that I had that amount coming to me except it would only land into my main account a few days after that deadline, but the $35 or so of interest I paid for dipping into my LoC for 10 days was only a tiny fraction of what I got back in my tax return for having invested so heavily into my RRSP, so it was money very well spent.
My LoC became the one and only ball I had to keep my eyes on, with the objective of bringing its balance down to zero. If one day I had to use my credit card for car repairs or whatever unexpected event that got thrown at me, I would immediately move the outstanding balance to my LoC, for if a purchase on a credit card is paid off within 21 days of the date of purchase, you pay no interest.
In fact, today I use my credit card for almost all the purchases I make — there are a few for which I’m forced to use cash/direct debit or cheques — and I just pay it off every week. In so doing, I get a bit of money back every month that I use to replenish my gas fund. Indeed, when you budget and keep track of every penny you spend as you spend it, you never have to guess what the outstanding balance on your credit card will be on your next statement. In fact, because of delays in moving funds from my main chequing account to the credit card and for some purchases to clear, my formal monthly credit card statement often has a negative balance as if I’d overpaid.
During that period when I was getting out of debt, because the interest payment on my LoC was taken automatically from my chequing account every month, I treated that fee as one of my recurring monthly payments. As the amount kept going down from the amount I used to set my budget, I used the excess to pay down my debt even more. I built two sheets for this account in my workbook so that I would know, almost to the penny, how much interest I would have to pay on the 8th of the coming month.
When I started my budget, I was pissing away well upwards of $70 a month just on interest for the LoC, but by paying it down at the rate of about $225 per paycheque plus whatever extras I could scrape up, the monthly interest payment started to go down very quickly — as in, in the mid-$60s in only three months of effort. If you quibble that you can’t see how throwing an extra $5 here and another $10 there against a huge debt could possibly make that much difference, I refer you again to this posting to prove to you that it does.
What you need to figure out about yourself with regard to credit cards is whether you can view them — and thus use them — just as if they were cash or a debit card while always remembering that whatever limit you have on a card is NOT your money. It’s the bank’s money, and they’re lending it to you at a considerably high cost. So, during your debt-elimination period, you must view them as an emergency measure to pay for something your need, not want, but for which you don’t have the cash on hand in your chequing account at the moment.
If indeed you can view them like that and if you never, ever carry a balance on them — unless you’re in the situation described in Part 6 of this series, in which case this “never carry a balance” rule will become your objective once you’re out of debt — then they’re not the evil that many people say they are. Be careful about one thing, though: If you pass that 21-day grace period, you pay interest from the date of purchase. So a partial payment (or worse, a minimum payment) doesn’t cut it, because you’ll still pay interest on the full amount of the purchase, not just what’s left to pay on the purchase. (Yes, that’s in the fine print of your credit card agreement, so I can see why people assume that credit cards are inherently pure evil.)
If you don’t have a LoC as I defined above, you need to look into getting one. If your credit rating isn’t in tatters and you approach your bank and say that you want to use it to consolidate and eliminate your consumer debt, they’re likely to give it to you. (In Part 6, I’ll show you an alternative if the bank refuses you a LoC.) They might, however, want you to get rid of all but one of your cards and lower the limit on the one you get to keep, but that’s a good idea because you don’t want your pool of available credit to be too high. Remember that your credit card use will be limited to an equivalent of cash for emergencies when that cash isn’t available at the time in your chequing account, so be sure to ask for a comfortable but reasonably low limit on that card so that your total available credit with the LoC is equal to or only slightly higher than what you currently have. It’s up to you and your circumstances to define what that “reasonably low limit” should be, but the point here is to make the total amount you owe right now your Ground Zero from which you’re gradually going to crawl away.
So the bottom line is that if you’re willing and able to keep your wants in check and spend only when you have the money while you’re in consumer debt elimination mode, you can keep ONE credit card.
What about the debit card? Well, the jury’s still deliberating on that point but I say that it depends on the individual. For me, strangely enough, cash in my pocket is far more dangerous than using my debit card. Indeed, for me, if cash is in my pocket, it’s meant to be spent and I tend to do so mindlessly. However, if I have to pull out the debit card from my wallet, I’m very conscious of the fact that I’m about to spend on something. If in that sense you’re the opposite of me, then I suggest you look into Gail Vax-Oxlade’s “magic jars,” but do one or the other and don’t just carry on as you have been because that’s what landed you where you are right now.
That said, even if you’re one of those old-fashioned cash-and-cheques kind of guy or gal, I suggest that now’s the time for you to step fully into the 21st century and make arrangements so that all your recurring payments — rent, mortgage, power, phone, etc. — are debited automatically from your main chequing account. That way, you’ll always know the exact date the transaction will go through your account and you’ll never pay another late-pay charge in your life. Besides, it can be awfully tempting to “borrow” from one of your jars and then forget to “reimburse” that jar, and then that money won’t be there when you need it. As for those few remaining recurring expenses you must continue to pay by cheque (as I must for rent, for example), consider providing post-dated cheque and assume that it will always clear your account on the date written on the cheque even if you know from experience that it seldom does so.
Finally, if you don’t have an overdraft on your main chequing account, get one! That’s not to give you extra credit even though that’s theoretically what it is but to provide you a cushion in case of mistakes. If you’re the one who makes the mistake, like forgetting to move funds into that account when you were supposed to, swallow your lumps for having to pay for tapping into your overdraft and learn from your mistake. However, if a third-party makes the mistake or, heaven forbid, a fraudulant transaction goes through your account, you’ll be on firm ground to argue with your bank to have any fee incurred as a result of the mistake or fraud reimbursed to you. When my landlord made the mistake of cashing two rent cheques one month, the electronic trail was clear and obvious and the bank waived the bounced-cheque fee, the fee for dipping into the overdraft, and the interest I paid for each day I was in overdraft. It’s also not a bad idea to sign into your online banking every day just to keep an eye on things and immediately catch any mistake that might occur.
Now we’re finally getting to the point where you need to start building your debt-elimination plan, and this is when you really need to work on getting your shit in a pile. The centrepiece of my method is to make sure the money is always ready when you need it without having to think about it on the eve of a “payment due” date. It’s not going to be just a simple spreadsheet listing what you’re allowed to spend on this and that over a month and sticking to it! There’s a lot more to it than that, so hold on to your hats!