How to Survive a Recession

LESSON 15: Cut Your Credit Card Debt the S.M.A.R.T. Way

There’s nothing wrong with credit cards – as long as you pay promptly. Unfortunately many people carry increasing card balances as the economy heats up, then are faced with paying down their high balances after the market turns down. To deal with the increased default rate, credit card lenders raise rates, reduce grace periods, and increase late payment penalties, adding an additional barrier to paying your cards off.

So how do you get out from under this mountain of high-cost debt?

The S.M.A.R.T. plan to cut your credit card debt:

S = SIMPLIFY: Cut all your cards in half and throw them away, except ONE which you will use for emergencies only. Do not open any additional card accounts. You can close an existing account and open another lower-cost account, but you are not allowed to open any additional cards no matter how many offers arrive in the mail.

M = MODIFY: Call every one of your lenders and ask them to modify your rate by lowering it. Tell them the interest rates have dropped so they are making more money with no more risk. If you have a good payment history, remind the lender of this fact. If you are a homeowner with equity, tell them that. Tell them how much you have in the bank if it is substantial. Tell them you have other offers at much lower rates to switch, but you would rather stay. Remember, you can always switch later -- you're just trying to get a lower rate now. Assuming you have a good payment history and are employed with a reasonable amount of assets, most credit card lenders will drop your rate to keep you as a customer. If your payment history is spotty but you still have a job and assets, point that out and emphasize your commitment to make your payments on time. You may be pleasantly surprised.

A = ABODE: For most people the family home is their greatest asset. If you own a home with any amount of equity, take out an equity home loan and pay off as many cards as you can. Credit card loans are extremely expensive because they are unsecured by any specific asset. A home loan, on the other hand, is secured by the value of the property, which protects the lender from total loss if you default. Equity home loans are almost always 25-75% cheaper than credit card loans. By refinancing credit card debt with a home equity loan your cash outlay each month drops significantly, which dramatically accelerates repayment time and reduces interest costs. Furthermore, the U.S. and many other governments make interest on home equity loans tax-deductible within certain limits. Refinancing with a home equity loan not only reduces your debt payments, but it makes them tax-deductible – essentially converting a high-interest consumer loan into free capital. There is no better deal than that.

R = RATE: List your cards on a sheet of paper, with the highest rate at the top and lowest at the bottom. This gives you a clear "attack plan" where you focus on the cards with the highest interest rate first. Reduce all your payments to the other cards to just above the minimum amount. Then increase your payments to the highest rate card by the total of the reductions you made to other card payments. Over time this will significantly speed up the balance reduction for the high priced card. Repeat this exercise sequentially until all your cards are paid off.

T = TRANSFORMATION: If you cannot obtain a home equity loan, transform your unsecured credit loans into secured loans by borrowing against other assets such as automobiles, collectibles, securities (a “margin” loan), or trade receivables. This converts risky unsecured credit card debt into a secured loan with a lower interest rate. There may also be tax advantages if you are a business owner or executive, as the business can take out a loan against its assets, then re-lend the cash proceeds to you at a reasonable market rate, which is typically much lower than what credit card companies charge. Be sure to consult an accredited tax specialist before taking this route.