Credit Card Debt: Myth vs. Reality

July 20th, 2010 | Posted in Credit Card Debt

In 2010, credit card debt has become a very typical, normal part of growing up in today’s society… Carrying a ballooning monthly balance is normal, and taking on debt to keep up with the neighborhood families is routine. Many people start taking on debt in college and continue until their finances reach a breaking point. Only when things become completely out of hand, debtors feel like they need to address this very serious issue.

Credit cards are a big problem because they inevitably lead to overspending. There is something about the physical act of parting with paper money that is lost on the user when they just swipe a plastic card. This could be one of the reasons that the average U.S. citizen holds about $3500+ in debt! “Paying 15% interest” on a credit card debt is such a poor use of money, when it could be saved for for something important (like food, rent, family, or yourself!). Alot of people out there are stuck in bad habits when it comes to credit cards. There is alot of bad information, myths, and blatant lies about credit card debt. Read down the page as we attempt to squash the top 10:

Here are our top 10 myths and misnomers about credit card debt:

1) Charging high amounts on your credit card is good because you are building up credit history…

Good credit histories are obtained through responsible repayment of charges made over time. If you make alot of purchases but also carry a big balance or make late payments, your credit history will get dinged like the hood of a toyota. There is also something called the “credit to debt ratio” that affects your score. If you have a high limit, but max out your cards every month, it can be bad even if you pay it all off every month. If you only charge 1/4 of your available credit every month, that will give you a good boost. If you want to build your credit history, stick with 1 card over a long period of time and always pay off your balance every month.

2) Anyone can reduce their debt 50% by negotiating with credit card companies…

This isn’t exactly true. Negotiation of credit card debt is for people who are experiencing significant financial hardship. If you make good money, but have a high credit card balance, you are going to pay the entire amount back. On the other hand, if you can’t ends meet due to the loss of a job or medical issues, negotiating your debt might be worth a shot. Credit card companies negotiate with debtors in order to stop them from going bankrupt. The closer you are to bankruptcy, they more leverage you have to negotiate. These companies are the last in line to collect on a bankruptcy judgement, so they might reduce your debt in order to keep this from happening. But, it might not work, they have every right to refuse your attempts at negotiation. But you have nothing to lose by trying.

3) Credit card debt is acceptable when you are in college…

College is a time when many kids begin accumulating credit card debt. As recently as 2009, Credit card companies used to hand cards out with prizes and gifts, but the recent CARD Act has changed things a little bit. This act makes it more difficult for someone with NO job to get a credit card (Reasonably so…). When students can get hooked on plastic, they can be left with high payments on top of student loan debt, and that can lead to all sorts of problems. Credit card debt can even cause them to drop out in order to pay it back. School can be a tough time for kids financially, so they might turn to credit to get them through it. If they think it will be easy to pay back this debt when they get a job in four years, they might just be setting themselves up for failure.

4) Bankruptcy should be avoided at all costs…

Bankruptcy is something most people want to prevent at all costs, but sometimes it is absolutely necessary to stop the bleeding. If you are dealing with a huge credit card debt that is building up momentum because of a job loss or medical problem, bankruptcy might be a way keep this problem from escalating. When you file for bankruptcy a process called an “automatic stay” begins. The automatic stay will halt legal procedures, foreclosure, evictions, utility shutoffs, and other actions by creditors. When you go BK, the interest on your credit cards will stop adding up. This will give you time to formulate a plan, and not get bogged down with the overwhelming interest. But remember bankruptcy can stay with you a long time (up to 10 years). So learn everything you can before you commit to it.

5) Credit Card Companies can’t sue you over unpaid debt…

Credit card debt is defined as “unsecured debt”, meaning that there is no collateral attached to it like a home or automobile. Credit card companies don’t have the right to take your property if you don’t pay back your debt, but they can and WILL sue you. If you haven’t made a payment for 6 months or so, they can take you to court and get a judgement that could include the garnishment of wages, a levy on your bank account, or a lien on property. These are VERY serious consequences. If you don’t pay your debt back, they will find a way to get that money from you. After a period of time they will write you off as bad debt and may send your account to a collection agency. These agencies also have the ability to sue you and tend use much harsher tactics to recover their money.

6) Unpaid credit card debt will follow you for the rest of your life…

Contrary to popular belief, there is a statue of limitations on credit card debt. This helps keep a debtor from being bogged down their entire life by a single debt. The laws vary by the state that you reside in, but on average the SOL kicks in around 3 – 6 years after the debt was created. It can also be longer for tax debt. If you have an unpaid debt that collectors try to recover after the allotted time, they might be debt scavengers. Companies known as debt scavengers buy very old debts for a fraction of what it is worth. Many of these debts are very old and do not legally have to be paid. If you have a collector contacting you about very old debt that you think you don’t owe, you can send them a letter asking them to prove you still owe the debt. If they cannot prove it, you legally don’t have to pay.

7) Debt settlement is the same as debt management…

Debt settlement companies work to reduce balances by negotiating a lump sum payment with creditors. They do this by advising you to stop all payments and having you deposit money into an escrow account. When you have built up a significant amount of funds and you are far enough passed due that your creditor thinks you might go bankrupt, they will try and negotiate a settlement. This can work sometimes, but can also be risky. Debt management is a service usually provided by a non-profit credit counseling service. This service negotiates directly with your creditors and attempts to work out a deal to set up a re-payment plan. Usually this re-payment plan involves less interest, fees, or balance than the original amount. By working directly with your creditor you are bypassing alot of the risks that might be associated with debt settlement.

8 ) Paying the minimum is O.K.…

Making only the minimum payment is absolutely the worst thing that you can do. If you get stuck in the habit of doing this, be prepared for your finances to get really messy, really quick. The minimum payment is there for the credit card companies to make more money. They creates more profits for themselves, and you create more debt. Interest rates on credit cards are very high compared to other types of loans. They can range from 10%-20% on average. If you let this interest build up, it can have a snowball effect which might be difficult to recover from. A law was added this year which forces credit card statements to show the amount of time it would take to fully repay the balance, if the consumer only pays the minimum. This might help put into perspective, why paying only the minimum is a trap.

9) Canceling my old credit cards will improve my credit score…

This is unfortunately, not true. If you cancel old credit cards, it can negatively impact your credit score. But there are still some upsides to canceling it anyways. You have to weigh the  options. If you have an open account that you don’t use, you might worry about identity theft. Canceling the account will give you one less thing to worry about, and that might be more important than a slight decrease of your credit score. The decrease is also temporary, so if you aren’t currently applying for a loan, you shouldn’t sweat it.

10) Credit counseling will affect you as negatively as bankruptcy…

If you work with a credit counseling company it will be noted on your credit report, but your actual FICO score will not be affected AT ALL! Some creditors may see the mention of your history with a credit counselor as a negative, but some might only take the score into account. Whether they might count it against you, depends on the individual lender.  Some lenders might consider it as bad as a bankruptcy, but some will see it as a positive, that you were able to get yourself out of debt before it got the best of you. If you have a good amount of income coming in, and have other factors that are in your favor, this might trump the previous negative marks.