What is it about credit card debt that makes it so much worse than other types of debt?
Don't get us wrong, all debt is tough to deal with…but none quite like credit card debt. Aside from arguably being the most expensive debt due to their high interest rates credit card debt can be absolutely stressful.
The majority of other common debts, such as student loan debt, auto loans, and mortgages, all come with an end date. While it may not be your optimal situation to be locked into typically long repayment periods, such as student loans and mortgages, at least you are guaranteed the debt will be paid off as long as you make the required payments on time. This isn't the case with credit card debt. If you're only making the minimum payments on your credit cards, you could be facing endless years of debt.
So what are you supposed to do to pay off your credit cards in a timely and efficient manner?
We say, you should consolidate them.
Full Disclaimer Regarding Credit Card Consolidation
Myth: Debt consolidation saves interest, gives one payment and ends all your problems.
Truth: Debt consolidation is a tool that if used properly can be very advantageous, but is dangerous because you are only treating the symptom of a bigger problem... DEBT!
Consolidating your debt is not the end of your debt problem. The debt is still there, as are the habits that caused it — utilizing this strategy has simply moved it under better terms! The hard truth is, you cannot borrow your way out of debt. True debt help is not quick or easy.
Put quite simply, debt is the symptom of overspending and/or under saving. Our financial coaches will not recommend debt consolidation for a client. Why? Because debt consolidation doesn’t work.
Here Is The Reality
Statistics estimate that 78% of the time, after someone consolidates their credit card debt, the debt grows back. Why? They still don't have a game plan for their personal finances.
Credit card consolidation seems appealing because there is a lower interest rate on the overall debt and likely lower payment. However, the way you truly get out of debt is by changing your habits. You need to commit to composing a personal finance game plan and sticking to it. Live on less than you make and start paying down your debt. It is not rocket science, but it is emotional and requires a huge amount of self discipline.
If you are not willing to dedicate yourself to paying down your debt and living below your means then please stop reading now. We're serious, we want absolutely no part in worsening your financial situation. Because it would be reckless to use a TSP loan to consolidate you credit card debt if the underlying habit is not fixed.
The last thing we want is for you to take out a loan, pay off your credit cards, and then charge up your cards again—now you've done nothing but dig your hole twice as deep.
How Does Credit Card Consolidation Work?
Typically, an individual in credit card debt is trying to manage multiple cards which ultimately means managing multiple debts and payments. Unfortunately all of those debts and payments carry interest that accrues on a daily basis. By the time you pay a little more than the minimum on each credit card it can still feel as though you are completely depleting your budget each month and not making a dent in your debt.
One way to make your credit card debt a little more manageable is to consolidate your credit cards.
With credit card debt consolidation, you take all of your credit card balances and put them in one place. In many cases, it means you just make one payment, and only have to worry about one interest rate. This can help you manage your debt more effectively as you pay it down, and the fact that you aren’t dividing up your payments can help you reduce your debt at a faster rate.
When you consolidate your credit cards, there are two main options:
Obtain A Debt Consolidation Loan: You can obtain a larger loan then use that loan to pay off your credit card balances. Your new loan only has one payment and one interest rate, and that can improve the efficiency of your payments. In our case we are going to look at obtaining a loan from our TSP account.
Take Advantage Of Balance Transfers: Depending on your credit history, you can use a credit card balance transfer to consolidate some of your debt and possibly even get a 0% APR for an introductory period (Typically 6-18 months). Or you can get another type of loan, such as a personal loan or a home equity loan.
Consolidating your credit cards is about doing what you can to make a bad situation more manageable. With the right approach and mindset, it can also help you reduce what you pay over time and help you pay off debt quicker.
7 Steps To Consolidate Your Credit Cards Using a TSP Loan
Calculate Your Credit Card Payoff Date
The first thing you must do before anything else is figure out your current situation.
The Debt Repayment Calculator will show you how long it will take to pay off your credit card debt. Choose from making the minimum payment, a fixed amount of your choosing, or a time when you would prefer to be debt free.
Obtaining your credit score is an important step in rebuilding and maintaining good credit.
If you haven't done so already, take the time to check your credit score using the companies we've highlighted below:
Not to mention it's absolutely free.
0% Transfer Balance
A balance transfer is a credit card transaction that allows you to move, or transfer, all or part of the balance of one card onto another credit card.
With a 0% balance transfer, your interest rate on the balance transfer will be 0% for the entire promotional period, these typically range between 6 and 18 months. That means you won't pay any finance charges on the balance transfer until the promotional rate expires. For example, if your balance transfer has a 0% interest rate for twelve months, you won’t pay interest on your balance transfer for twelve months.
Since there is no finance charge, all of your monthly payment goes toward reducing the balance. Once the 0% balance transfer ends, the regular balance transfer interest rate will go into effect.
This is a fantastic alternative to obtaining a TSP loan. You pay 0% interest and do not risk missing out on gains in your retirement account.
Here is a list of credit cards that offer 0% transfer balances. But be advised these opportunities are generally for individuals with a good credit history.
Check TSP Loan Rate
We want to preface this before saying another word. Taking out a TSP Loan for your credit card debt should be your last and final resort. If you decide to move forward you must understand discipline is a must.
While 0% interest rate loans are ideal, they only last 18 months in the best case scenario. But "general purpose" TSP Loans can have up to a 5 year repayment plan. As a federal employee or service member who has contributed to their TSP account you are able to borrow against your contributions and their earnings.
As of February 2016, the current interest rate for TSP Loans is 1.875%
To get the most up to date interest rates for TSP loans you can check the official TSP website.
Does It Make Sense To Consolidate
In more cases than not, your typical debt consolidation loans don't make sense. While the lure of being able to pay off all your debt and replace it with one single payment is a tantalizing opportunity it's not perfect.
You have to do the math and consider these three things:
- New Monthly Payment - What will the monthly payment be on your TSP loan? Is it more or less than the total you're paying now for your credit cards? If the loan payment is more than you pay towards your debts (and it fits into your budget), it might be time to up the ante and just put more money to your credit cards.
- Total Interest Paid - Will you end up paying more interest over time based on the loan term of your TSP loan? In other words, calculate the difference in the amount of interest paid between your current credit card debt and a TSP loan. For example, a TSP Loan of $5,000 @ 1.875% over 24 months would accrue a total of $96 in finance charges if all payments are made on time. How does $96 compare to the amount of interest paid using your current credit card terms?
- Time - Will it take you more time to pay off your credit cards at the current payment rate or obtain a TSP loan?
- Future TSP Earnings - Does the amount of savings warrant disrupting your potential future earnings in your Thrift Savings Plan account?
Navy Federal has an excellent online calculator that can help you determine if it's in your financial benefit to consolidate your credit card debt.
Create A Debt Management Plan
The popular "Debt Snowball" and the "Debt Avalanche" methods are the two main strategies for paying down your debt.
The Debt Snowball method says you should start by paying off your debts with the lowest balances first, while the Debt Avalanche method tells you to pay off the debts with the highest interest rates first.
Imagine you’re on a small boat in the middle of the ocean and water starts pouring into your boat. You've realized you have a couple leaks, and see two main areas of water coming into the boat: there are three small holes in the front of the boat, and one large hole in the back of the boat. The 3 small holes are bad, but the large hole is wreaking havoc. Which do you start patching up first?
Most people’s gut reaction is obvious: patch the large hole or you're going to sink really quick!
However, if the leaks in the front and back of the boat were your debts, the snowball method would tell you to patch the small holes in the front of the boat first, because they are smaller. Then, after an early victory, you move on to patch the large hole in the back of the boat.
The avalanche method would tell you to patch the large hole first, because it poses the biggest threat and could potentially sink your boat. Here’s the reality: Your high interest debts are like that large hole in the back of your boat. Due to compound interest, they cause much more damage than low interest debt, no matter what size the debts are.
How big can the difference be in regards to how you pay down your debts?
Imagine you have the following debts:
Student Loan: $15,000 balance, 4.5% interest rate
Credit Card 1: $5,000 balance, 12.99% interest rate
Credit Card 2: $25,000 balance, 29.99% interest rate
If we assume you can pay $3,000 per month to get out of debt, your debt payoff timeline using the Snowball method would look like this:
- Snowball Method = 16 month payoff and total interest paid: $9,416.16
- Avalanche Method = 14 month payoff and total interest paid: $5,979.26
Using the avalanche method, you would be debt free a whole two months earlier, and save $3,436 in interest! Simply paying your debts in the wrong order in this situation would have cost you over three thousand dollars!
The difference may not always be as large but the avalanche method always wins in terms of time and money saved. But we can’t forget about the emotional aspect of paying down your debts. While it makes more sense logically to pay down your high interest debts first we have to take into account some individuals may get discouraged along the way if they are not seeing progress. If you fall into this category then by all means use the snowball method.
Stay Out Of Debt
Remember our primary goal is to get you out of debt and make sure you stay out of debt. Perhaps taking a TSP Loan in order to consolidate your credit card debt doesn't make sense or maybe it does. Whatever the case you cannot afford to be riddled with debt and you should use every tool you have to get out of it.