If you have explored all the other options available for dealing with debt, including professional help, bankruptcy is there. Previously a taboo subject, bankruptcy has seen a rise in recent years, and to some does not carry the stigma it once did. However, considering it will affect your life for 7 to 10 years, so it is not something to take lightly.

Types of Bankruptcy

Individuals are eligible to file for bankruptcy under Chapter 7, 11, 12 or 13.

Chapter 7

Here, individuals or businesses forfeit nonexempt assets to repay debts to the fullest amount and walk away from the rest. To qualify, individuals must be take a ‘means test’ to determine if they make less than the state’s mean income.

Chapter 11

Also known as reorganization, this type of bankruptcy is for individuals and more commonly, businesses to restructure debt. Here the debtor maintains ownership of assets and attempts to work out plan to pay back creditors. It is the most complicated form and usually reserved for businesses or very wealthy individuals. The reorganization and payment plan is due in under 120 days, as part of the 2005 Bankruptcy Abuse Prevention and Consumer Protection Act.

Chapter 12

Unusually reserved for farm owners and fishermen. The debtor still owns assets, and works out a repayment plan. It works very much like Chapter 13, but usually stretches out over three years.

Chapter 13

Much like Chapter 11, but for individuals with personal debt. Debtor remains in control of assets, but repayments are repaid in planned structure.

7 Myths on Bankruptcy

1. Everyone will know – unless a person is a well-known celebrity or corporation, there is little chance of people finding out, outside the creditors. Although the filings are made public, with the large amount of filings it is unlikely people will find out without doing an extensive background search on you.

2. All debts are wiped out under Chapter 7 – some debts are not discharged or erased. Child support and student loans for example, will remain afterwards.

3. I’ll lose everything – every state has exemptions from judgment, including housing, cars, and household possessions. That means you can keep some of the essential items you need, as long as you show you will be able to afford them after discharge.

4. Never be able to borrow again – often it will be contrary. You will usually start receiving many offers right afterwards, from sub-prime lenders offering credit at high interest rates.

5. Difficult to file – actually, it’s not even necessary to have attorney. If you can fill out the paperwork, you can go at it alone if you want to.

6. Filing will help my credit score, as the debts are removed – very incorrect. On a credit report, a bankruptcy is about as bad as it gets. It can remain on a report for up to 10 years. However, in some cases your credit score may go up shortly afterwards depending on how bad you let things get out of hand before you filed. Either way, having it on your record will now be worse overall.

7. You can only file once – Chapter 7 is once every eight years. Chapter 13 you can file more often. Of course, it is extremely bad for your future credit score if you have multiple bankruptcies.

Consequences

Credit – after bankruptcy it should come as no surprise that both your credit score and report will be severely affected. It will linger on a credit report for 7 to 10 years, regardless of your situation then. Getting credit cards or loans will be more difficult than before, especially at a reasonable rate.

Employment – most employers today run not only a background check, but also a credit report on potential employees. With the weak job market, and employers being able to be more selective than ever, a bankruptcy can be a reason against getting the job. The question “Have you ever filed for bankruptcy” will be forever answered.

Emotional – many times people feel a strong sense of guilt after bankruptcy. Although the stress of creditors calling has ceased, the stigma remains. This negative thinking however, will do no help. Remind yourself that you are not alone, with over 2 million Americans filing last year.

Housing – even renting an apartment or home can become a challenge. As most places require a credit report for the rental application, an approval is difficult with a bankruptcy on the record. An additional deposit, or co-signer will most likely be needed.

Managing Your Finances After Bankruptcy

• Make a budget – As basic as it sounds, keep and maintain a budget. If you need help, there are many services which will help you make and maintain a budget so you can live within your means.
• Cash – Learn to use cash more, and plastic less. It is easy to fall back into the same habits; however, learning the old phrase “cash is king” is an important step after bankruptcy.
• On time – Pay everything on time. Even power and phone companies will report late payments. It is critical to keep the new record clean if you are to rebuild your credit.
• Watch your credit report – with the new clean slate you are given, it is important to keep an eye for any mistakes. Monitoring your credit is a necessary step post bankruptcy.
• Get a new credit card – A secured credit card can be a great step in the right direction after a bankruptcy. Here you deposit a set amount of money in a bank, and this becomes your credit limit. By charging small amounts each month, and repaying on time, you begin to rebuild a solid credit history.
• Watch for scams – There are many offers out there to take advantage of people in their fragile state after bankruptcy. Watch out for any companies offering to ‘fix’ everything, especially if they require a large upfront fee. There is no quick way out, and anything which sounds too good to be true, most likely is.

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There are all sorts of debt management help out there today, and navigating it can be difficult. Below are some options and things to watch for when thinking of turning to a pro.

Signs you should consider professional help:

1. Credit Card payments are rising while income is steady or decreasing.
2. Unable to even meet minimum payment.
3. Using one credit card to make payments on another.
4. You are at or very close to the limit on all your credit cards.
5. You add more debt than you pay off each month.
6. You are unsure how much you owe, and afraid to find out.
7. You have received phone calls or letters about delinquent bill payments.
8. You are buying everyday things such as groceries with credit cards.
9. You are dipping into savings or your IRA to pay your monthly bills.
10. You use your credit card not as convenience but by necessity.

Credit Counseling

Most of the services offered fall under the umbrella of ‘credit counseling’. Credit counseling is a custom tailored plan to provide guidance and support for people who need help getting out of debt. The goal most times is to avoid bankruptcy, and provide education on financial management to help avoid the same problem again. Many of these services also negotiate with a person’s creditors on their behalf to reduce interest or rearrange repayment structures.

Debt Management Program

“Debt Management Program (or Plan)” is another phrase often mentioned when discussing professional debt management. This is not separate from credit counseling, but a tool used under the same umbrella. A DMP is a workout proposal usually made by your credit counselor agreed to by the creditors. The DMP is the money left over after developing an accurate budget with your counselor. The disposable income is directed towards the credit counselor, who in turn allocates it to the various creditors. The credit counselor acts as the intermediary, to help communications from both ends.

Debt Settlement

“Debt Settlement” is the final term often discussed within this discussion. This is a process by which a large, one-time payment is made for forgiveness of remaining debt. Although the thought of paying back less than is owed is tempting, there are no free lunches. Any amount forgiven is viewed as taxable income by the IRS, which can come back to haunt you, unless you file for bankruptcy. In addition, it will show up on your credit report for some years, and make it very unlikely a lender will approve you for an affordable loan.

Shopping Around

As with anything else, it pays to comparison shop. There are many companies offering credit counseling, and finding the best deal can take a little research. But don’t be fooled if the company claims to be ‘nonprofit’. This often can be misleading, as they will oftentimes actually charge higher fees than other ‘for profit’ businesses.

According to the Federal Trade Commission, the following questions should be asked to any prospective credit counselor:

• What services do you offer?
• Will you help me develop a plan for avoiding problems in the future?
• What are your fees?
• What if I can’t afford to pay your fees?
• What qualifications do your counselors have? Are they accredited or certified by an outside organization? What training do they receive?
• What do you do to keep information about me (including my address, phone number, and financial information) confidential and secure?
• How are your employees paid? Are they paid more if I sign up for certain services, if I pay a fee, or if I make a contribution to your organization?

Click here for a list of approved credit counseling by state.

Have you used any debt management or credit counseling services in recent years? If so, did it help? We’d love it if you’d briefly share your experience with us and others seeking professional help, in the comments below.

Thanks!

Next we cover the ins and outs of bankruptcy…

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1. Rearranging Credit Cards
2. Auto Loan Refinance
3. Tapping 401k
4. Borrowing from Friends and Family

Rearranging Credit Cards

When it comes to credit cards, not all are the same, and in a time of financial distress, not all should be kept. An important step in debt management is eliminating the cards which are keeping you in the furthest in the red.

When starting to look over your current credit card situation, keep the following points in mind:

• Which card has the lowest interest rate? The highest?
• Do any of the cards charge a yearly fee?
• Do you have any cards you never use?

Once these questions have been determined, follow these steps:

1. Pay off any cards with low/no balances and close the accounts.
2. Transfer the rest of the balances to the card with the best interest rate, and the lowest balance transfer fees.
3. Don’t use this card until it is paid off.
4. Determine which two or three cards to keep and repeat this process until only those remain.

Things to watch for when consolidating credit cards:

• Canceling a card with a balance. This can cause your rate to increase dramatically, as issuers often raise rates on the balance if they know you will close the account.
• Find out balance transfer fees beforehand. It only takes a simple phone call or statement review.
• Continue making minimum payments on all cards until transfers complete. Assuming the transfer went through and missing a payment can be costly.

Auto Loan Refinance

Another point to look to when rearranging your debts is your car loan. Often times, there are ways to reduce your monthly payment, interest rate, or loan term, all saving you money.

The first and easiest step would be to contact your current lender and inquire about a rate modification. If you have been regularly paying on time there is a chance a simple phone call could land you at a lower rate.

If you have not been paying on time, or the lender is not budging on rate, it is time to looking into refinancing.

• Obtain your credit report and score to determine where you stand
• Determine if your current loan has any prepayment penalties
• Determine the current value of your car, and compare to the amount owed
• Use this knowledge to shop for a better rate.

There are many routes to take here, and speaking with loan originators with this knowledge is the best way to find out if a refinance is the right move.

Note: If you owe more than your car is worth, it will be difficult to find a low rate. A lender will not have enough collateral to replace funds loaned if things go south, so they won’t likely even approve your refinance request.

Tapping 401k

A last resort option, yet an option none-the-less in a climb out of debt is to use your 401k or other retirement savings plan. Many are unaware they are able to do so, yet it is possible.

How

First, speak with your company’s 401k administrator. This person likely works in accounting or human resources. Also, there is often a toll free number on your plan’s statements. Explain what you would like to do, and they should be able to help.

Prior to making that phone call, it is important to understand some of the pros and cons of taking money out of your 401k.

Pros

• You are borrowing from (and paying interest) to yourself, not a credit card company.
• The rate is usually low, 1 or 2 percent above the prime rate
• There is no credit check
• Repayment is usually through payroll deductions, which is easy for most people
• Low transaction costs

In most 401(k) plans, you can borrow up to 50 percent of your vested balance, but not more than $50,000. You have to pay the money back with interest over five years.

Cons

• Plan management companies may charge fees, up to $400 for an application fee
• Money removed does not appreciate as it would if left in the account
• Once repayment begins, your overall deductions could double if you are to maintain your current contribution schedule
• If you leave the job, the loan accelerates and must usually be paid between 60 and 90 days
• If the loan is not repaid, it is considered an early withdrawal and taxed very heavily

Of course if you’re already retired that could change things slightly.

Retirement savings should be just for that, retirement. If your current situation finds you where you need to dip into your future savings, there will come a time where there are no savings to dip into.

Borrowing from Friends and Family

Borrowing from friends and family will always depend on the relationships each person has. As often stated, mixing finances with family and friends is an easy way to hurt feelings and ruin relationships.

However, if you decide this is the route for you, it is important to put things in writing. Although we all assume nothing bad will happen, it is a prudent step to put the following down:

• The names of the lender and borrower
• The date of the loan initiation
• The amount
• The date by which the loan is to be repaid
• The interest rate, if one is applied
• The number of payments
• How often payments are to be made (weekly, biweekly, monthly), and
• The minimum amount to be paid

Another step to ensure comfort on both sides would be to put up some type of collateral. All lenders would require this, and it should be no different with friends and family.

Next we go over tips for getting credit counseling services…

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From the advertisements on TV to pamphlets from various street corners, debt consolidation seems to be the buzzword of the moment.

It basically involves taking all of your debts and combining them to a single loan. This is often achieved through home equity loans, lines or credit, or refinancing.

While consolidating this debt lead to a lower interest rate, especially when compared to credit cards, there are several things to consider.

As with any debt management plan, consolidation is not the ultimate answer to debt management. Without changing the spending habits that brought you to this point, debt will never truly be under control.

Potential Benefits

• streamlining your bill payment process
• extending your repayment term
• lowering your interest rate
• switching from a variable to fixed-rate loan
• lowering the monthly payment amount

Potential Disadvantages

• paying more in total interest
• having a larger total loan repayment amount
• extending your loan period, meaning you’ll be paying longer
• losing borrower benefits from your current lender (rebates, etc.)
• turning unsecured debt into secured
• possible prepayment penalties

Ways to Consolidate Debt

Now that you are aware of the pros and cons, how does one go about a personal debt consolidation?

The three most common routes are:

1) Home Refinance

Also known as a ‘cash out refinance’, where  you take out a new mortgage for more than you currently owe on the house, and use the difference to pay off the other debts. The interest rate is typically lower than a home equity loan; however there are almost always closing costs associated with this route.

2) Home Equity Loan

A home equity loan is a separate loan on top of your first mortgage. It is also secured by your property; however as opposed to a refinance; you don’t typically have to pay closing costs for a home equity loan. Rates are usually higher than a refinance; however, the savings in closing costs can negate this difference.

3) Home Equity Line of Credit (HELOC)

In contrast to the first two, a home equity line of credit is more like a credit card. You agree with the lender on a limit which you can borrow up to, over a defined period of time. As you borrow, you can also repay, reopening that credit. The interest rates are typically variable; however, you are only paying interest on the current amount borrowed.

Things to Consider

Current Mortgage

It is important to consider the rate on your current mortgage. If you have secured a lower rate than currently available, then you would likely be best not refinancing unless you absolutely have to. There is no reason to start paying a higher interest rate on the entire amount of the home, to borrow a small percentage. Likewise, if rates are currently much lower than when you took out your mortgage, refinancing may be a very attractive option.

Unsecured vs Secured

When you roll credit card debt into the above options, you take an unsecured debt, and make it secured (by your home). Regardless of threats made by credit card companies, they cannot take away your home for failing to repay. Once that debt is secured by your home, if you are still unable to meet payments, now the creditor can come after your real estate. If you are still uncertain you can meet the payments, even after consolidation, you are best to look for other routes prior to putting your home on the line.

Next we cover other ways to clean up debt…

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Debt is money, goods, or services owed by an individual to someone else. Someone who owes a debt is called a ‘debtor’.

There are many causes for a person to go into debt, but the 10 most common reasons for people to do so are:

Causes of Debt

1. Reduced income/same expenses
2. Divorce
3. Poor money management
4. Underemployment
5. Gambling
6. Medical expenses
7. Saving too little or not at all
8. No money-communication skills
9. Banking on a windfall
10. Financial illiteracy

Identifying your sources of debt can help you find areas which could be improved, or costs which could be cut.

“Bad Debt” vs “Good Debt”

The above causes are the most common to contribute to the accumulation of what experts would describe as ‘bad debt’.

This is the more common form of debt, and the one most Americans are familiar with. Bad debt is accumulated when people forgo using savings and instead use credit to buy disposable items or everyday goods. It includes credit cards, auto loans or putting things on layaway. This type of debt is not looked favorably upon, and is a common cause of stress in people’s lives.

On the flip side is ‘good debt’. If debt is accumulated for a reason that is likely to produce value in the long run, it is commonly called ‘good debt’. It can include student loans, home mortgages or business loans. All these types are looked upon generally favorably by creditors, and with good reason.

It’s important to remember that not all debt is bad.

How much debt should I have?

Asking how much debt you should have is a common question when trying to understand your personal debt situation. The most common term to address this question is ‘debt load’.

Debt load is also known as the debt-income ratio, and as such, describes the amount you owe, compared to your income. First, add up your monthly payments, including your mortgage (principal, interest, taxes, and insurance) and home equity loan payments, car loans, student loans, your minimum monthly payments on any credit card debt, and any other loans that you might have. Do not include expenses such as groceries, utilities and gas. Take this total and divide it by your gross monthly income from all sources.

For example:

Monthly income- $2,000
Monthly debt- $500
$500/$2000 = 0.25

this gives you your debt/income ratio, which is 25% in this case.

Usually you want to keep this number below 36%. This number is often confused as some companies do not include house payments and utilities. If these are excluded, the total should not be above 28%. This is often known as the ‘28/36 rule’.

Next we cover debt consolidation…

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There is almost always an APR associated with an auto loan, credit card or home mortgage. All of which we’ll cover in detail below.

Credit Cards

APR associated with credit cards is generally the most straightforward.

When thinking of a 20% APR on a standard credit card you divide it by 12 to roughly get the rate that will be applied to your balance monthly (approximately 1.67% in this case).

.20 / 12 = 1.67%

This rate can be charged as a “fixed APR” as well as a “variable APR”.

Fixed Rates -
A fixed rate is what it sounds like, a rate that is fixed during the charge period.

Variable Rates -
Variable on the other hand is tied to a published rate, often the US Treasury Bill Rate or Prime Rate. The rate will be expressed “prime rate + your rate”. This is updated at set increments, even daily. Although variable rate cards often offer lower introductory rates, they can also cause trouble for consumers if the rate resets too high for them in the future.

Calculation Methods

The calculation using the APR, fixed or variable, can change from company to company and card to card:

Average Daily Balance -
The credit card company averages your daily balance throughout the month. Specifically, they look at your balance each day, and divide that by the number of days in the month. That amount, multiplied by approximately 1/12 your APR would equal the finance charges for the month.

Daily Balance -
Using this method, companies calculate the finance charge based on your outstanding balance each day. This daily amount is multiplied by approximately 1/365th of the APR to determine the daily finance charge.

Two-Cycle Balance –
This method is the most expensive. Here, the company charges interest on debt already paid. They take the average daily balance over the past two billing cycles and charge interest on it. The bad thing is that extra payments made to reduce your balance won’t affect the previous balance, so you’ll have to pay a higher rate, even after reducing your balance.

Previous Balance –
Companies issue a statement showing the balance at the beginning and the end of the month, and charges interest on the beginning.

Loans

When constructing an APR for a loan, there are a lot of the related costs and fees included that are required to originate the loan, which are left at the discretion of the lender. The formula varies from institution to institution depending on the type of product and length of the loan– there is no official standard as of yet. And there are fees that cannot be predicted in an APR such as an early loan payoff fee, late payment fee or fees incurred if you refinance the loan.

In 2008, an amendment to the Truth In Lending Act states that if the final APR is off by more than .125% from the initial disclosure the lender must notify the borrower within three business days before closing on the transaction. There are also many reform bills in congress presently that (if passed) will change the disclosure process and may place interest limits and other regulations on financial institutions. Credit laws also vary from state to state.

So basically when you see an APR advertized what you’re looking at is the percentage per year you will be paying on the amount of money you borrow. APR is a good starting point for comparison, but depending on the amount of the loan and length of time you will be borrowing the money, a closer examination of the fees involved would be prudent. Another factor to consider is whether the money is compounded daily or monthly as this will make a big difference on the total amount you will be paying.

Auto Loans (other bank loans)

The APR can be even more deceptive and confusing when financing or leasing through an automobile dealership or vendor financing. A markup on a vehicle can in fact be hidden in the APR making the metric meaningless as a point of comparison. This is actually a common practice when financing through a car dealership.

Say an automobile is leased (or sold) to a customer at the manufacturer’s suggested retail price and at a low APR. The dealership will in fact accept this lower lease rate in exchange for a higher sales price. The customer has received cheap financing in exchange for a high purchase price. If the customer had self financed the dealer would have accepted a lower sales price.

In short this makes the advertised APR meaningless as it understates the true cost of the financing. The only way to find the true APR would be to determine the lowest acceptable price for the vehicle, arrange the financing yourself, then go back to the vendor and compare their financing terms.

The process gets even more muddied when there is a trade-in involved or the lessee has a purchase option at the end of the lease and the value of this option is not transparent.

Mortgage Loans

Mortgage loan financing is more complicated but not nearly as shady as the aforementioned financing vehicles (accept maybe for the sub-prime fiasco). As stated above the fees that are included in an APR for mortgage purposes vary between institutions and are subject to change through legislation but in general the following fees are involved in a typical home mortgage– headlined by their relevance to an APR.

Generally included:

• Origination fees including
• Loan processing
• Underwriting and document preparation
• Closing agent’s document preparation fees
• Private mortgage insurance (PMI)
• Attorney and notary fees
• Pre-paid interest
• Points

Sometimes included:

• Life insurance
• Application fees

Generally not included:

• Credit report costs
• Home-inspection
• Appraisal
• Title fee

In summary the annual percentage rate (APR) is generally a good tool when shopping around for financing of one form or another. However, it is not the only thing you should be looking at once you have narrowed down your choices, because it can often get confusing and misleading.

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It’s important to keep your personal finances secure; otherwise you could find yourself in a world of hurt if someone malicious get’s a hold of your information.

If someone steals your identity they could use thousands of dollars of credit before you even realize what has happened. Once you do figure it out, you’ll need to contact all of your creditors, call your banks, open a case, and you may even be required to go to court to ensure you’re not liable for any possible misuse.

General Security Procedures

Here are some basic tips for staying on top of your credit card security to help you avoid a major hassle in the future.

Sign your card- although many people overlook this as a silly check these days, it’s still important to sign your card (or write ‘see ID’ for added security).

Keep your receipts- do not leave your receipt behind if using it an ATM, or elsewhere. This can leave you vulnerable to fraud. Additionally, after reviewing your statements (if you get hard copies) shred them prior to disposing.

Careful over the phone- don’t give your credit card info over the phone unless you initiated the call. This is a common scam, and even seemingly legit phone numbers can be picked up by nearby scanners. Be particularly cautious if you get a call right ‘back’ after placing an order or talking to your credit card company. If this happens, hang up and recall the original number to check its status and legitimacy.

Ignore any credit-card offer that requires you to spend money up-front- or fail to disclose the identity of the card issuer.

Remember to get your card back- it is easy to forget to recollect your card after using it at stores. As simple as it sounds, make a habit (such as leaving your wallet up) until you retrieve your card.

Keep a list- of your current credit cards and their toll-free numbers in case of emergency, theft, or loss.

Keep up with statements- check for any suspicious charges or errors.

Shopping Safely Online

Internet shopping is made possible through the use credit cards. The explosion of money changing hands virtually has attracted many hackers to prey on this market. However, there are steps you can take preemptively to protect yourself against issues shopping online:

Zero Liability- some credit card issuers offer zero liability clauses for online purchases. If the card or its number is stolen, typically the cardholder is responsible for up to the first $50, but none after that.

One Time Use/Temporary Numbers- some companies issue temporary numbers that you can use for just 1 web purchase. So even if the number is captured, it can’t be used for anything else.

Extra Passwords- some cards require an additonal password to be entered online if attempting to use the card, hopefully known just by the company and you. Not all online merchants have this capability, so it will only provide protection on the sites which do.

Be Careful- sometimes credit card companies will attempt to sell customers on protection in case the card is stolen and they are left with a huge bill. It’s important to know that consumers are already covered by a federal law (outlined below). Personal liability is capped at $50, and the issuer will rarely even ask for it if it’s reported stolen in a timely fashion.

Disputing Charges

When reviewing your monthly statement, if you do come across a suspicious charge, it is important to take action quickly. However, you can also rest assured that there is protection provided by the government for this exact reason:

The Fair Credit Billing Act- passed in 1975 is an amendment to the Truth in Lending Act. Like the name states, the main goal of the act is to outline consumer’s rights when it comes to errors that arise on credit card bills.

Key points of the Act:

• Allows consumers, when dissatisfied, to sue or assert other defenses against their credit card companies.
• Requires consumers to make a “good faith attempt to obtain satisfactory resolution of a disagreement or problem relative to the transaction” from merchants.
• Restricts these rights to transactions exceeding $50.
• Protects you without requiring you to buy additional credit protection.

If you do spot a billing error on your statement the first move is to return to or call the merchant and attempt to resolve it. This is often the most effective action to take. If it doesn’t work, call your card issuer to see what they suggest. They’ll likely request that you put the complaint in writing and send a copy to them via certified mail.

During this time of dispute, make sure to continue to pay on the card for least pay the minimum payment due. While many companies will likely give you the benefit of the doubt, and credit your account for the amount disputed, they can also deny your claim and may possibly even charge you additional fees if you haven’t been paying the amount due on your statements.

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Having a credit card isn’t what gets some people in trouble, it’s the way they use it that does.

Common Problems:

1. Getting too many credit cards

The temptation to receive a free gift or otherwise can lead a person to obtain many credit cards. There is very few times when having additional cards lying around will benefit the consumer. Even if the credit cards are left with a zero balance, the lender may wonder why and what will happen if the consumer was to max out all of the cards, and as a result, make changes to the cardholder’s terms.

2. Misunderstanding introductory rates

The 18 months of zero interest may sound appealing, and even provide rationalization for opening a new card to ‘transfer over’ a balance and save on interest charges. However, a common mistake is not looking at what happens when this introductory period is over. Often, when the rate jumps, it jumps high, putting the consumer in an even worse spot than before.

3. Not reading the fine print

Within the fine print is where you’ll find the rate the card changes to after the introductory period, as well as balance transfer fees, grace periods, and all other relevant information that is part of ‘doing your homework’ prior to obtaining a new credit card.

4. Choosing a card for the wrong reasons

You’ve always wanted to go to Hawaii, and that free round trip ticket from your new credit card will get it done! Or, you are freezing cold at the ballpark and there is a credit card company offering free blankets with sign up (it happened). Either way, the wrong reasons often lead people to sign up for credit cards they dont need, or do not fit with. The credit card company’s job is not to match each consumer with the best card for their needs, but rather to issue more cards. So be wary of the gimmicks involved with getting you signed up.

5. Not rate shopping

When an envelope arrives at your door with ‘preapproved’ written on the front, and two airline tickets that could be yours, it is tempting to just accept the offer. Most of these unsolicited offers will not have the best available rates, however, and you will likely pay for it through various fees in the long run.

6. Making minimum payments

Carrying a balance on a credit card is how the companies issuing them make money. It’s also the way that consumers get in trouble. Credit cards should not be used as supplemental income, but merely as a convenience tool that gets paid off every month. Paying the minimum amount due, because that’s all that is required, is the quickest way to find yourself behind the debt 8 ball.

7. Paying your bill late

Not only will you face a late-payment charge, which could be higher than your minimum payment, your tardiness will show up on your credit report, damage your FICO score and make it harder to get better terms on future loans and accounts.

8. Ignoring your monthly statement

By not carefully reviewing each month’s bill, you will definitely not be monitoring your own spending habits well, and could possibly be ignoring someone else’s too. In the days of ID theft it’s imperative to check each statement religiously to make sure there are no unusual charges.

9. Exceeding credit limit

Not all cards will be declined if they have reached their credit limit. Many will allow charges to go through only to later hit the user with fees and a lower credit score. By taking into account rule 8, regularly checking your statement, and knowing your credit limit, you should be able to avoid crossing the balance, which that will have a negative impact on you if you do.

10. Buying things you don’t need

Basic rule, but it’s one that is perhaps most often broken. Credit cards are a tempting way to purchase things. The old rule about waiting 48 hours to purchase something can greatly reduce impulse buys, or other buys that upon reflection weren’t necessary. If you need added self control, some suggest freezing the credit card in ice, so when you are tempted to make that online purchase, you have to wait until it melts prior to using it again. The thought being that by the time your credit card thaws out, so has your urge to shop.

Next we cover credit card safety and security…

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Considerations When Looking for a New Credit Card

Why do you need a credit card?

Some people may want a new credit card to transfer a balance so they can save some interest for a few months. Others may use it primarily for work expenses, just for travel, or a student getting their first credit card looking to build their credit. All of the above reasons, and thousands others, are common, and do not dictate the same card as the correct choice for each person. It is important to look at why you want/need a credit card first, before getting caught up in the perks.

How much do you plan to charge to the card?

After the above question, you should think about how much you plan to typically charge. Although this credit limit won’t be completely in your control, it will help you narrow down your sights on a few cards. Perhaps you’re a student building credit and want to maintain a low limit to not get yourself in too much debt at any one time. Or, conversely, a business owner who is seeking a card with no credit limits in order to put ongoing large purchases on it.

How often will you pay the balance in full?

Do you plan to pay off the entire balance each month? If so, perhaps a card with a higher interest rate but much better perks would be best for you. If you plan on carrying a balance, you may want to steer to the lowest interest rate credit card, rather than one with the best perks. Regardless of the exact situation, it is important to be honest with yourself and examine your previous payment and spending habits.

Are you extremely loyal to one specific gas station, bank, airline, retailer, etc?

Some credit card companies offer great benefits to use their card at a specific retailer or merchant. If you know that you only fly on Continental for instance, and travel often, you may want to look at which cards they have to offer. Only fill up at Hess? They probably have a credit card for you.

Important Points to Consider

Annual Percentage Rate (APR) alone isn’t everything

The stated interest rate alone may not be the best indicator of the right card for you. The way APR is calculated can vary, as well as annual fees, teaser rates, perks, etc.

Card perks may hurt

Cards with perks (miles, cash back, etc) may have higher interest rates, or annual fees, which make it actually a worse deal for you than a traditional card. However, if you know your spending habits, and rarely carry a balance, some of these cards offer really great deals. It’s important to see the true savings of any particular costs compared to the increased finance charges, or other fees.

Am I truly pre-approved?

Offers coming in from the mail often proclaim that you are ‘preapproved’ for their credit card, and may even include a fake card with your name on it to get you excited of what’s to come. In reality however, pre-approval doesn’t account for much these days – it simply means the credit card company is aware of your credit score and history, but will still require you to call-in, post-mail, or complete your application online for final approval. This may or may not be at the same terms stated in the pre-approval letter.

Although the right card will not be the same for each individual, a few questions will help any person find the ideal card for them.

Questions to Ask Yourself When Shopping for a Credit Card

1. Is there an Introductory Rate? What is it and how long does it last?
2. Is there an Application Fee?
3. Is there a Processing Fee?
4. Is there an Annual Fee?
5. What is the Late Payment Fee?
6. What’s the Over Credit Limit Fee?
7. How much are the Balance Transfer Fees?
8. What’s the Grace Period?
9. If I go over limit or pay late will my terms change?
10. Can I Pay Online, and are there any savings for signing-up for Online-only Statements?

Next we cover how to use credit cards wisely…

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Otherwise, you could be surprised by a number of huge costs and fees you never anticipated.

Basic Interest Rates and APR Fees

At the most basic level interest is the fee paid for the privilege to borrow money. The financial firms lend out money and they charge you for allowing you to do so. The rate charged can vary for each consumer based on how confident the firm is that you will pay them back, and what your credit score is.

In the United States the average interest rate on a credit card is typically between 15 and 20%. While this may be tough to call ‘good’ or ‘bad’ to many consumers, it is important to put this in perspective.

When thinking of the 15-20% interest rate on a credit card, it’s important to remember that this is expressed as Annual Percentage Rate (APR). So at 20%, you would divide this by 12 to roughly get the rate that will be applied to your balance monthly (1.67% in this case).

This rate can be charged as a “fixed APR” as well as a “variable APR”.

Fixed Rates

A fixed rate is what it sounds like, a rate that is fixed during the charge period.

Variable Rates

Variable on the other hand is tied to some type of published rate, often the US Treasury Bill Rate or Prime Rate tracked here. The rate will be expressed “prime rate + your rate”. This will be updated at set increments, even daily. Although variable rate cards often offer lower introductory rates, they can cause trouble for consumers down the road if the rate resets to a much higher percentage.

Calculation Methods

The calculation using the APR, fixed or variable, can change from company to company and card to card:

Average Daily Balance

The credit card company averages your daily balance throughout the month. Specifically, they look at your balance each day, and divide that by the number of days in the month. That amount, multiplied by approximately 1/12 your APR would equal the finance charges for the month.

Daily Balance

Credit card companies calculate the finance charge based on your outstanding balance each day. This daily amount is multiplied by approximately 1/365th of the APR to determine the daily finance charge.

Two-Cycle Balance

This is one to look out for because it can be the most expensive. Here, the credit card company charges interest on debt already paid. They will take the average daily balance over the past two billing cycles and charge interest on it. The bad thing here is that extra payments to reduce your balance won’t affect the previous balance, so you’ll have to pay a higher rate, even after reducing your balance.

Previous Balance

The credit card company issues a statement showing the balance at the beginning and the end of the month, and charges interest on the beginning.

Other Typical Fees

Finance Charge – usually charged monthly based on the APR, balance and grace period.

Cash Advance – charged each time you take a cash advance and is usually 3% or more of the amount withdrawn.

Balance Transfer – fee that is charged each time you transfer money from one credit card to another. You only pay the fee to the card issuer you’re transferring the balance to.

Minimum Payment – the lowest amount of money you’re required to pay by a certain date to avoid defaulting on the agreement and receiving any late fee penalties for doing so. It’s usually a minimum percentage or dollar amount.

Late Payment – fee applied whenever you don’t pay your minimum payment due by the due date.

Over Limit – some companies will allow you to charge more than your available credit limit; however, they will also charge you a hefty over the limit fee.
Next we go over important things to consider when choosing a credit card….

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