Digging out of debt; the lunacy of minimum credit card repayment; personal loans; revolving credit; and comparative credit card rates

By Amanda Morrall (email)

We have a real cross section of readers who visit our website. Some of them have the equivalent of a Ph.D. in personal finance, some are new entrants and others are half way through their bachelor degree. The great thing about this site is there is something for everyone.

Regardless of financial literacy levels I think most people intuitively know the dangers of debt. Whether and what they're doing about it is another matter. Quite often those who are saddled with high debt suffer from a paralysis. Ironically, many end up causing themselves more harm because they continue to feed the addiction, rather than do something about it. There's a sick psychology at play.

I am happy to say I have no debt. I am debt phobic. In part, it has something to do with having been hit with an STD (sexually transmitted debt). I wasn't a total victim. I willingly took it on because I believed that the fastest way to cure it was to tackle it as a team as we had the benefit of a double income. Financially I know it was the right decision. Emotionally, I'm not so sure. Between my resentment and the ex's guilt, we sank together like the Rena. In theory we should've sailed to a happy destination. The silver lining is that we both learnt from the experience, in different ways.

In any case, there are a few different ways to get out of debt. One of them is the snowball method where you start with the smallest and work your way up. The idea is that the smaller debts are easier to knock off both psychologically and financially. It's a confidence building approach, sort of like dieting. You start with a more modest and realistic goal as a way to build up your confidence because you're more likely to see results, even if they are slow coming. We all know how well Oprah did with the extreme measures diet.

A more direct route to debt destruction is the debt consolidation approach. Maybe this is similar to starvation because it does involve a fair bit of sacrifice but it does work for some people.

Only you know which approach will work best for you. If you're a binger, than perhaps the snowball. If you know yourself well enough and you can avoid the Haagen Dazs in the freezer at midnight, then perhaps the starvation route of debt consolidation. Or perhaps, a strategy that lies somewhere in between these two.

1) Breaking the habit

That was my really long and rambling way of linking to this story from the debtmyth.com on avoiding a relapse into the credit zone, which is key to the effectiveness of any debt reduction plan.

2) Minimum repayment

One size does not fit all in personal finance. That's because everyone has different financial behaviour and goals as well. Some of us are self-managing and highly disciplined. Others are financially oblivious or just muddling their way through without giving it too much thought. The strategy you use to get out of debt will depend on your personality. One of the reasons I don't like the snowball method is the ridiculously high interest rates underlying even those small loans. I'm thinking mainly of credit card debt, particularly if it's drip-fed on a minimum repayment basis. Painful!

If you want to see just how much, check out of credit card minimum payments calculator here.

3) How long

The first principle of getting out of debt should be a resolve not to acquire any additional debt as you tackle your existing debt. If you do have to borrow ask yourself if it really is essential. Then do the maths to see what it'll cost on a long-term basis and how long it will take to repay..

This calculator from sorted.org will show you the true long-term cost of borrowing and also how long it will take to repay that debt. It's a goodie.

3) Personal loans

I saw an ad the other day for a debt consolidation "deal" at 14.95%. I struggle to see the deal here. There is healthy competition among the banks these days. Check out our personal loans section here to see what's on offer before you sign up for the first deal that is thrown your way. As I talked about earlier this week on TVOne's Good Morning show, you need to approach banks and other lenders as you would a Moroccan bazaar. Haggle, haggle, haggle. If you're not up for it, conscript your bossy boots friend, father-in-law or whomever has that boldness to do it on your behalf. The other option is borrowing from a family member and keeping the money in the family. Family loans aren't without risk either but an alternative worth exploring if you, and they, think it'll work without ending in tears or worse.

4) Revolving credit

It could be, depending on your situation, that a revolving credit facility might be a better, cheaper way to pay off your debts. That said, in the wrong hands, revolving credit can lead to a lifetime of debt. Know thy money habits, manage your cashflow carefully and prosper.

Here's a break down on the revolving credit rates on offer among competing banks here in NZ.

5) Credit cards

If you're smart about it, credit cards can be used to your advantage. If you pay the balance off in full every month, get the points and use the grace repayment period to your maximum advantage. Personally, I don't like this method. I think the plastic lends itself an artificial sense of having money that most of us don't, and it can be too easy to miss the deadlines for repayment. But as I said before, one size does not fit all. I know plenty of people who master their cards like nobody's business.

Here's a comparative listing of credit card rates which also shows the interest rate period. Make sure you know your billing cycles so you don't get caught out.

To read other Take Fives by Amanda Morrall click here. You can also follow Amanda on Twitter@amandamorrall