The Debt Dilemma
Let’s say you owe $5,000 on your credit cards and are paying 18% interest. Assuming you make no new purchases and pay a fixed $150 each month for the next several years, it will take three years and 11 months to pay off the original debt.

You’ll also end up paying approximately $2,000 in interest. That’s a lot of money to pay for credit!

As of 2007, the median amount of credit card debt carried by the average American household was $6,600, according to CardTrak.com. Robert McKinley of CardTrak estimates that the average American household pays some $1,500 a year in credit card interest.

From a financial planner point-of-view, credit card debt should be limited to investment items such as the purchase of a home. That’s because credit card debt (and credit card interest), unlike some other kinds of debt, is not tax deductible.

Additionally, credit incurred in the purchase of a home (an asset) can ideally be resold for profit, as well as be used as a tax deduction.

From Debt to Savings?
The credit card debt that many people carry also presents an opportunity for considerable savings. Eliminated credit card debt can free up money that could be devoted to everything from luxury items to investments.  For example, an easy way to earn 18% or better is to get rid of credit card debts as soon as possible.

“Let’s say you have four credit card debts. The first thing I would recommend is to categorize all of your debts,” said Charles Hughes, a Certified Financial Planner in Bayshore, New York.

“Instead of making four equal payments on all of the cards, consider making the biggest payment on the card with the highest interest rate.” Hughes also said that as you reduce debt, you should keep a cash reserve to avoid running out of money. Otherwise, after running down a credit card debt, you could quickly fall back into the red.

Also avoid new debts that will pile on the existing ones. Put cards away for a while and try to pay for daily purchases in cash.

As debt declines and one starts achieving goals, “a person will become enthusiastic about eliminating more and more debt,” Hughes said. He added that the same techniques can be used to build up savings, but credit card debt should be eliminated first.

Making Cards Work for You
Once you have gotten out of the habit of paying interest on cards, there is a way to make cards work for you. However, the credit card companies expect that most people won’t use this technique.

Most cards “provide the consumer with an interest-free loan from the date of purchase to the date of the billing,” writes David Evans and Richard L. Schmalensee, credit card industry analysts. That means the card company has extended you an interest-free loan. However, remember that this grace period generally does not apply when you take a cash advance on a credit card, which is probably the most expensive way of accessing credit.

Card companies, which are under pressure to obtain as much business as possible to survive, refer to the sage cardholders who pay off balances each month “transactors.”

So why do companies offer them free loans?

Because they know that many customers will be “revolvers.”  In other words, most people will carry some kind of credit balances from month to month, which is the main way the credit card companies make their money. The card companies also try to get as many revolvers as possible and (of course) hope that some transactors will become revolvers, too.

Generally speaking, the average person shouldn’t be paying more than 10% of net take-home pay on credit card and other consumer debt.  You should be able to repay all of it within 12 to 18 months.

Saving $1,500 a year in credit card interest may not seem like much – and it probably isn’t over the short term. But over the long term, it’s huge; over 30 years, it adds up to $45,000 in interest savings.

Conversely, if you took $100 per month ($1,200 per year) of that $1,500 and invested it in a mutual fund that earned an average rate of return 9% per year.  At the end of 30 years, you would have roughly $184,000 before taxes.

…All because you started using credit more intelligently and invested your money instead.

You’ve just seen how the difference between $45,000 of credit card interest over 30 years and the amount gained by investing can be substantial.

by Gregory Bresiger — a business writer living in Kew Gardens, New York. He is managing editor of Traders Magazine and the editor of CQ&D, Traders Magazine’s clearing quarterly. He also frequently contributes to the New York Post Sunday Business Section and the publications of the Future of Freedom Foundation, a libertarian institute in Virginia.Gregory Bresiger is a business writer living in Kew Gardens, New York. He is managing editor of Traders Magazine and the editor of CQ&D, Traders Magazine’s clearing quarterly. He also frequently contributes to the New York Post Sunday Business Section and the publications of the Future of Freedom Foundation, a libertarian institute in Virginia.