Credit Card Debt

When used responsibly, credit cards can help you build up your credit score and earn all kinds of rewards, such as travel rewards and even cash back. However, if you give into the temptations that come with having credit cards in your wallet, and spend more than you can afford to repay, your cards could actually do more harm than good and leave you with a mountain of credit card debt.

What is Credit Card Debt?

In its simplest definition, credit card debt is an unsecured form of debt you build up by spending more money with your credit cards than you can afford to repay in full in a given billing period. A 2013 survey by Abacus Data found that 70% of Canadians pay off the entire balance of their credit cards each month ¹, which means close to one-third of Canadians have credit card debt.

When you look at how credit cards work, you can understand how easy it is to overspend. Not only do you have access to hundreds or thousands of dollars of available credit, it’s easy to get sucked into the minimum payment trap – knowing that you can spend up to your limit and only have to pay a small portion of that back each month.

For that reason, it’s not surprising that credit card debt accounts for 5.5% of the total household debt in Canada (with residential mortgages making up 70%)². Unfortunately, credit card debt can be a serious burden and, if you choose to only make the minimum payment each month, you could be stuck with it for years.

Example of Credit Card Debt and the Minimum Payment Trap

For the past year, Sarah has been spending more on her credit card than she could afford to pay off each month. Now, she’s maxed out at her card’s $5,000 limit. To keep the numbers simple, let’s say her interest rate is 20% and her minimum payment is either 3% of the balance or $15 – whichever is greater.

Using this calculator, we found that if Sarah decided to only make the minimum payment each month (3% of the balance), it would take her 221 months – or 18.42 years – to pay off the $5,000 balance. What’s more, in that amount of time, she would also pay $5,860.86 in interest – or more than double her original debt.

The minimum payment doesn’t look quite as appealing now, does it?

Instead, if Sarah’s budget allowed for her to make a fixed payment of $300 each month, it would take her just 20 months – less than 2 years – to pay off the $5,000 balance. In that amount of time, she would only pay $906.84 in interest, because more of her payment would go to paying down the principal, which would also lessen her monthly interest costs.

As you can see, by paying more than the minimum amount each month, you can save significantly in interest costs and pay off your credit card debt much sooner. However, we know it can sometimes be easier said than done.

Methods to Repay Your Credit Card Debt

If you’re currently facing a mountain of credit card debt, there are a number of options you can consider:

Option 1: Write a budget and make credit card debt repayment a priority

If you truly want to get out – and stay out – of credit card debt, the first thing you need to do is admit that you’ve been overspending. You’ve been letting more money go out than you’re bringing in, and that is a spending habit you need to change.

To start, we suggest tracking your spending for a few months. If you use debit or credit for everything, you could log into your accounts, or use apps like Mint, and look at the last three months of expenditures. Once you have a sample of data, you can usually see where you’ve been overspending – and where you can cutback in the future.

With these numbers, you can also write a monthly budget. Remember that all your expenses have to add up to – or equal less than – the amount of money you take home each month. In your budget, you should have a line for credit card debt repayment and a goal to make more than the minimum payment each month.

Option 2: Do a credit card balance transfer

If your credit card has a high interest rate (19.99% or more), you could also consider doing a balance transfer. Balance transfer credit cards offer promotions for low interest rates – some even as low as 0% - for a specific period of time. For example, one card could offer you 0% for 10 months. You could take advantage of this offer and transfer some, or all, of your balance onto this card, then pay it off without the high interest costs your original credit card would’ve had.

The most important thing to remember when you do a balance transfer, however, is that you have to repay the entire balance in full before the promotional period is up. If you forget to pay even $0.01 of your balance, you will be charged interest on the entire amount that you originally transferred. Since balance transfer cards often come with even higher interest rates (e.g. 24-29%), not paying off the balance within the promotional period could wind up being even more costly.

To use a balance transfer card effectively, make it the top priority in your debt repayment. For example, if you only transfer 50% of your balance onto one of these cards, focus on making large lump sum payments on this card while making only the minimum payments on your other credit cards. Once the balance transfer card is paid off, allocate more money to your other debts each month, until they are all paid off.

Option 3: Consolidate your debt

Finally, if you are completely overwhelmed by your credit card debt – and any other debt you may have – another option to consider is a consolidation loan. We don’t suggest working with specific debt consolidation companies, as they charge a fee for their services. Instead, just sit down with someone at a bank or credit union, and ask if you can take out a personal loan and use it to consolidate your debt at a lower interest rate.

If you’re a homeowner, refinancing your mortgage to consolidate your other debts into it may be another option to consider. Of course, you’ll have to pay a mortgage penalty, and potentially legal fees, but these costs may outweigh the interest you would pay during the years you would carry your outstanding debts.

Before you consolidate your debt, you should still write a realistic monthly budget, to determine how much you can afford to put towards debt repayment each month. The bonus of taking out a loan is you only have to make one payment each month, versus multiple payments to multiple lenders. But you should still have a monthly budget outlined, so you know if you can comfortably afford the monthly loan repayment amount your bank quotes you.

Choose the Right Credit Card For Your Needs

To avoid this situation altogether, there are things you can consider when choosing which credit card(s) to keep in your wallet:

• First, if you’re young, are not making much money and/or you just want to start building up your credit, get a card with a low limit. There’s no reason for you to have a $5,000 limit, when $500 is all you really need – and can afford to repay.
• Second, unless you’re paying off the balance in full each month, get a card with no annual fee. There’s no reason to get a rewards credit card if you can’t pay off the balance each month, because the high annual fee + interest rate will likely outweigh the rewards you earn.
• Finally, if you think there’s any chance you’ll carry a balance from month-to-month, you should look at low interest credit cards. For example, it may make more sense for you to pay a $20 annual fee to have a credit card with an interest rate of 10% versus $0 for a credit with an interest rate of 20%, if you know there’s a chance you’ll carry a balance.

Remember that credit cards, when used responsibly, can help you build your credit and potentially earn some great rewards. However, it’s still important to find the right credit card for you and try to pay off the balance in full each month. If you

References and Notes

1. Credit Cards: Statistics and Facts , Canadian Bankers’ Association
2. Credit Cards: Statistics and Facts , Canadian Bankers’ Association