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Tackling debt

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Tackling debt

Over the last few decades amassing debt has become an American way of life. In fact, many are subsidizing their lifestyle by using credit cards - racking up the most expensive, least rewarding kind of debt.

And we use those cards a lot. The American Bankers Association estimates there are 10,000 card transactions made every second around the world.

Credit cards are intended to be a tool of convenience. Carrying cash can be a little clunky. Imagine whipping out 1,000 greenbacks to pay for a television. Plus, cash doesn't offer reward points. And you can lose it with no recourse. But I'm a still a big fan of using cash because paying with actual bills tends to keep us out of financial hot water. If the cash runs out, our spending stops...not a bad arrangement.

Using credit wisely can be beneficial, however. You can improve your credit score, hone your money management skills, and earn travel points and cash back for purchases, just to name a few.

In the not-so-smart credit use category, CreditCard.com says U.S. consumers charged an estimated $51 billion worth of fast food on their cards in 2006. Now, that is a good time to whip out the greenbacks instead...or better yet pack more lunches!

From a glass half full perspective, the current recession has coaxed many Americans to whittle away their debt. While we've shaved tens of billions off the total, we still owe an astonishing $866 billion in revolving debt. The 2009 Nilson Report states for all who carry credit cards, the average balance is a whopping $9,700.

So, why, you ask, is debt such a bad thing? There are two primary reasons. First, paying down debt ties up monthly cash flow that you could use for other more beneficial - or fun - activities. Or my personal favorite, saving for the future.

And the other? Why squander your hard earned cash by paying interest on that hot date you enjoyed six months ago or the trip to Disney, especially if you're still paying interest long after the memories have faded. There may be legitimate reasons for carrying debt, such as medical bills exceeding insurance coverage, helping a family member or adopting a child. Still, the goal should be to zero out those balances as quickly as possible.

Aside from the practical reasons, having too much debt can also negatively impact your lifestyle and military career.

Heavy debt loads will drag down your all-important credit score because what you owe comprises 30 percent of the calculation. That three-digit number is an at-a-glance indicator to a financial institution as to whether or not they consider you to be a good enough risk to loan you money. And -- if so -- at what rate?

Let's say you want to buy a $200,000 home. You have stellar credit and are able to qualify for a 5 percent interest rate. Financing 100 percent of that cost means your monthly payment would be around $1,074 per month. If your credit is marginal and you lock in a 6.5 percent rate, your payment would be close to $1,264. A $190 difference may not seem like much, but you sure wouldn't pass it by on the sidewalk! That extra cash could help put a dent in your card balances, allow you to build savings or mean some quality time with your family and friends.

But beyond the monthly out-of-pocket costs, over the life of the 30-year loan you would pay an additional $68,573 in interest at the higher rate.

If you're not in the market for a house and prefer to rent, it still matters. Your potential landlord will likely check your credit score to ascertain your credit worthiness. Why? They want the best possible chance of collecting that rent check the first of every month.

But how can debt negatively impact your career? When I applied for my job at USAA, they checked my credit. Why? One who manages their money well may be more likely to manage their job well too.

For those of us in uniform, numerous career paths require a security clearance. Thousands of clearances have been revoked, suspended or denied based on significant debt. The government may view you as a higher security risk if you are in financial jeopardy. Another reason to ensure your financial house is in order.

One Department of Defense official stated, "Financial issues are by far the leading cause of clearance revocation and they are rising at a significant rate. As you might expect, it's not just younger members, but senior and established members have the same issues."

Now let's discuss how to get out and stay out of debt.

1. Gather statements. Some folks have avoided opening their credit card statements altogether. Sticking your head in the sand is not a plan. Open them. Like my mom said, and probably yours, too: You have to face the music.

2. Collect data. Review charges for accuracy and highlight the pertinent details, such as the current balance, credit limit, interest rate, and minimum payment due.

3. Know what you owe. Add it up and determine where you stand.

4. Develop your plan of attack. Now it's time to figure out how you are going to actually get out of debt.

a. It's very tempting for many folks to turn to debt settlement. That is "settling" with your bank for less than what you owe. However, using debt settlement will destroy your credit score which will cost you more money in the long run via higher interest rates on mortgage and auto loans as well as future credit cards. Additionally, that "forgiven" amount would likely be viewed as taxable income. This is a double whammy: ruining your credit and incurring a tax bill.

b. I like the concept of debt consolidation much better. This is packaging all of your balances into one loan with a fixed payment and a beginning and end date. Sounds great, right? It does unless you find those zeroed out cards too tempting to resist. If you haven't gotten your spending under control you may run those balances up again and also owe on your consolidation loan. Ouch.

c. Don't ever hesitate to ask for help. Debt can be overwhelming, depressing and certainly stressful. Seeking guidance through the National Foundation of Credit Counseling, NFCC.org, can be a comforting and effective way to get back in the financial driver's seat. Another option is to simply choose to pay off each card one by one. And, that is my recommendation.

5. Rack and stack. If you have chosen to pay off each card one by one, there are two separate and distinct approaches to tackling debt in this way. The one that makes the most mathematical sense is to pay all you possibly can on the card with the highest interest rate while paying the minimum on the others. Zero the debt out on the first card and then take that dollar figure and apply it to the card with the next highest interest rate while continuing to pay the minimum on the other cards. On the other hand, some people need a quick win. Taking the opposite approach of paying off the smallest balance first while paying the minimum on the other cards works, too. You will pay a little more in interest, but let's face it...many people accumulate credit card debt simply because they want immediate gratification. For example, if you're the type of person who doesn't want to save for a television, but wants to purchase it today, the latter tactic may work best for you.

With an average of five credit cards in our pocket, don't feel alone if you have credit card debt. The lack of discipline to pay off the entire balance each month plagues millions of Americans. But don't become another statistic. Pay cash. Live within your means. Use credit cards only for convenience.

This material is for informational purposes. Consider your own financial circumstances carefully before making a decision and consult with your tax, legal or estate planning professional.

USAA means United Services Automobile Association and its insurance, banking, investment and other companies. Banks Member FDIC. Investments provided by USAA Investment Management Company and USAA Financial Advisors Inc., both registered broker dealers.

USAA Financial Planning Services® refers to financial planning services and financial advice provided by USAA Financial Planning Services Insurance Agency, Inc. (known as USAA Financial Insurance Agency in California), a registered investment adviser and insurance agency and its wholly owned subsidiary, USAA Financial Advisors, Inc., a registered broker dealer.

Certified Financial Planner Board of Standards, Inc. owns the certification marks CFP® and Certified Financial Planner TM in the United States, which it awards to individuals who successfully complete CFP Board's initial and ongoing certification requirements.

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