10 bad habits that lead to debt disaster
Monday June 16, 6:00 am ET
Sometimes the only way to stop a snowballing problem is to go back to the top of the hill and find out what started it.
If you're up to your eyeballs in credit card debt, take a step back and recount your money missteps. Knowing your weaknesses could help prevent you from falling back into the bad credit pit and show you a way out.
According to Gail Cunningham, vice president of business relations at Consumer Credit Counseling Service of Greater Dallas, a nonprofit financial management service, consumers mired in debt make common financial blunders, most of which they can prevent with discipline and behavior changes. Learn from these mistakes and start paying off your debt.
10 bad habits to break
Bad Habit No. 1: Misusing balance transfers.
Transferring balances on high-interest cards to lower-rate cards can be an effective technique, but it's easy to make it a good idea gone wrong. Transfer a balance onto a card with a low introductory rate and you can potentially save money on interest if you refrain from charging on it and focus on paying off the balance before that introductory rate expires. But most people continue to charge on the new card and wind up with more debt once the teaser rate expires, says Cunningham. In fact, new purchases may pull an altogether different interest rate. Read the fine print very carefully, and only attempt the balance-transfer maneuver if you can control your spending on the new -- and old -- card.
Try this: If you can't refrain from charging, balance transfers won't get you out of debt. If you're really in the hole, consider getting a part-time job and dedicating your earnings to your debt load. If that's not possible, go back to your budget and cut back on unnecessary expenses such as restaurant outings and cell phone extras. Put the money you save toward paying off your balances. Pay for new purchases with cash or debit.
Bad Habit No. 2: Not checking credit reports -- you can't change them anyway.
Wrong. If you have credit cards, pull your credit report at least once a year and check it for errors. Purging your record of inaccuracies can be crucial for getting better interest rates, landing the job you desire and stopping an identity thief from ruining your credit rating. Your credit report also affects your credit score, which determines how high your interest rates will be on future loans. Dispute anything you think should not be there. The Fair Credit Reporting Act allows for the correction or deletion of inaccurate, outdated or unverifiable information, provided that a reinvestigation into the disputed data sides in your favor. Unfortunately, negative but truthful data must stay put. A Chapter 7 bankruptcy filing, for instance, will remain on your credit report for 10 years, a Chapter 13 for seven years.
Try this: You can request one free copy from each of the credit reporting bureaus, Experian, TransUnion and Equifax, every year. Why bother? Errors on your report, such as a payment marked late that came in on time, could raise your interest rates, lower your credit score and affect your ability to obtain credit in the future.
If you do find a mistake, send a correction letter to each of the credit bureaus that show the error. Experian allows you to dispute errors online, as do TransUnion and Equifax.
Don't bother with so-called credit repair clinics that aim to charge you hundreds or thousands to fix your credit record. "Anything you can legally do to repair it you can legally do for free," says Cunningham. Of course, if you're not willing or dedicated enough to write those letters and follow up with the credit-reporting agencies, paying someone else to do it for you may not be such a bad idea. Better to have someone dispute the errors rather than no one. But be extremely careful in selecting such an organization -- try to get referrals and seek out others who have been satisfied with the service.
Bad Habit No. 3: Failing to alert creditors about a financial hardship.
You heard the rumor: Layoffs are coming to a department near you next week.
Don't wait until it happens to worry about how to pay your bills. Do some damage control right away.
Try this: "The best time to negotiate is before the problem spirals downhill," says Cunningham. Call the credit card company and explain the problem you're about to have. Ask if they could temporarily lower your interest rate or extend your payment deadline. Some issuers have in-house help programs that provide such short-term services to customers.
Bad Habit No. 4: Thinking of "budget" as a dirty word.
The word may call to mind tedious self-trickery meant for those with low incomes, but everyone could benefit from deciding on certain amounts for spending and sticking to the amount no matter what. It also makes sense to budget for known future expenses, such as quarterly insurance premiums, college textbooks and rent. Not saving up in advance means you'll have to charge expenses or cut into funds set aside for necessities. Budget these fixed costs while you can handle small financial pinches.
Try this: To find out what's draining your finances, keep track of where your money goes for a month. Use a spreadsheet, financial software or a pen and paper and categorize your expenses. Doing this will reveal whether you're spending too much on expenses you could trim, such as restaurant outings and gas. Then you can consider cooking at home more often or consolidating driving trips. Cut back as necessary without cutting out expenses important to you. Cunningham suggests that if you enjoy watching TV, but don't tune in to a majority of the 300-plus channels you have, consider cutting back on your cable package instead of cutting out TV altogether.
For a detailed household spending plan, try our home budget work sheet. Or, get help creating a budget with our budget calculator. Plan for future costs by figuring out the total amount you'll owe and divide by the number of months you have until that day, says Cunningham. If you have money due next month, divide by the number of weeks you have and save that amount every week.
Bad Habit No. 5: Using retail store credit cards to make use of discounts.
Chances are, that card carries a high interest rate you'll be forced to deal with if you don't pay off your balance each month.
Try this: If you must charge your purchase, use your general-purpose credit card, says Cunningham. If you can't pay off the balance, at least you'll pay a lower interest rate. Limit the total number of credit cards you have to just two, if you can: one you can pay off each month and one with a low interest rate for those large purchases you'll pay back over time.
Bad Habit No. 6: Procrastinating on creating an emergency fund.
Learn to save for financial emergencies. Even if you feel robust and invincible, a single emergency room trip or car accident could force you to put large balances on credit cards, causing interest to accrue and more debt to pile up. "That rainy day will happen," Cunningham says. "It's not a matter of if, it's a matter of when." If your tire goes flat and you can't pay upfront for the replacement, for instance, you're stuck with charging it or reducing funds earmarked for necessities. That's where the emergency fund fits in.
Try this: Maintain an emergency fund of at least three to six months' worth of living expenses, and keep your insurance policies up to date. Work toward that goal by socking away 10 percent of your take-home pay each month in a liquid savings account, says Cunningham. If you receive a raise or bonus, add that money to savings. Since you're not used to the extra cash flow, you won't miss it.
Bad Habit No. 7: Denying yourself a financial education.
Trial and error makes for the best money lessons. If you've ever been wronged by a car dealership, applied for a credit card to get a discount on merchandise or threw away a receipt for a major purchase you needed later, you've made preventable money mistakes.
Education can make all the difference. "We find that few consumers have received financial education in schools or at home," says Cunningham. People are relying on their own judgment or their peers' advice for major money decisions. Unfortunately, the advice given isn't always sound or unbiased.
Try this: When faced with a financial decision new to you, get educated before you take action. If you've never had a credit card before, go online and learn how they work and what kind of card you need. If you're new to investing, research investment types and the potential risks and returns associated with them. If you want to save for your child's college tuition, learn about the best savings plans now. Research takes time and patience, but it will save money.
Bad Habit No. 8: Charging purchases instead of paying in cash or with a debit card.
How many times have you charged services or merchandise when you had the money to pay with cash or debit? Insignificant purchases of $20 and $30 made several times over can quickly add up, particularly if you already carry a balance. Balances you can't pay off each month mean paying interest charges and, subsequently, more money for items you could have bought outright, interest-free.
Try this: Make a habit of paying for purchases under $50 with cash, debit or check. Knowing that the money has to clear the bank sooner could help curb your spending habits. Just be sure to check your balance regularly to ensure that you have enough funds.
Bad Habit No. 9: Making credit payments late.
After all, it's only a $39 late fee. Besides wasting money you could've put toward the balance, a payment that arrives at least 30 days past due can throw your account into default and triple your interest rate. Plus, other creditors may start charging you a default interest rate as well, thanks to a universal default clause buried in your contract. "Creditors are constantly reviewing your credit activity, and if they see you falling behind with one creditor, even if you have a perfect payment history with them, they can raise your interest rate," Cunningham says.
Try this: On a calendar, mark upcoming paydays and payments that should come out of that paycheck, she says. If you're mailing payments, send them seven to 10 business days in advance. Better yet, sign up for online bill pay. Just check that the address on file and the address on the statement match, or the payment might not arrive on time. If you're still late, call the creditor, explain the situation and ask them to forgive the late fee. Check your credit report and be sure the information shows up correctly.
Bad Habit No. 10: Making the minimum payment only.
Paying the minimum is better than paying nothing, but it doesn't do much to pay off most balances and forces you to keep paying interest. By paying interest on interest, you lose any savings from buying a dress on sale, Cunningham says.
Try this: If you can afford to pay more or in full, go ahead and pay as much of the balance as you can. You never know when you're going to have a tough month. Pay in full every month and you can avoid interest charges altogether.
Or, if paying more than the minimum proves difficult, consider working an extra part-time job or decreasing your expenses -- or both, says Cunningham. Put all of your extra earnings toward the debt. Use our minimum payment calculator to see how much you're saving in interest charges.