Credit card debt is very different from the kind of debt you take on when you take out a mortgage or a car loan, and not just because it tends to come with much higher interest rates. Here are the four ways in which credit card debt differs from other types of loans, and why you need to be careful when taking on credit card debt.
1. You don’t know what your monthly payment will be. One of the most critical parts of managing debt is to know that you’ll have enough money each month to make your debt payments. With credit card debt, the monthly payment may go up without notice, if the credit card company decides to increase the monthly payment from the more typical 2.5% of the balance to e.g. 5% of the balance.
This could cause the monthly payment due to increase considerably and even double. So, where before you had budgeted enough money to pay the monthly dues on your credit card debt, you might now find yourself falling short each month. For millions of consumers struggling to make ends meet, this can be enough to tip them over the edge into credit card default or even bankruptcy.
2. You don’t know what the interest rate will be. If you have a variable rate credit card, which is becoming increasingly common, you never know exactly which interest rate you’ll be paying on your cards. If the underlying index changes, the interest on your credit card debt will go up, and this in turn will also cause your monthly payments to increase.
3. You don’t know how much credit you have available. With a car loan or bank equity line of credit, you know exactly how much credit you have access to and can plan accordingly. Not so with credit cards. Your credit limit can get cut at any time at the card issuer’s sole discretion, as credit card companies indeed have done over the past year for millions of consumers. In fact, the more credit card debt you carry on your credit card in relation to your credit limit, the more nervous card issuers get and the more likely they are to cut back on your credit line.
4. The credit card doors can quickly slam shut. Many people recycle their credit card debt from one card to the other to keep the interest rate low. For example, if the card issuer changes terms in ways they don’t like, some card holders simply turn around and apply for another credit card, and then transfer the balance on to the new card.
However, all it takes is a drop in your credit score to slam this door shut. If your credit score drops below excellent, which these days is considered to be at least a score of 750, you may find yourself struggling to get approved, when you apply for a new credit card.
What might cause your credit score to drop? The obvious reasons are not paying a bill for more than 30 days or missing a credit card payment. However, your score can easily drop due to no fault of yours. For example, if you have credit card debt and one or more of your card issuers lowers the limit on your credit card, your credit utilization ratio will increase. This is a measure of what percentage of your available credit you are using up, and it accounts for 35% of your score. When your card limit(s) decreases, your credit card debt takes up a larger percentage of your total credit limit, thus undermining this important part of your credit score and potentially causing your score to drop.
Once your credit score goes down, you could find the doors to new credit cards closing real fast, and find yourself stuck with credit card debt at 24.99% or higher. And, at this point, unless you have some money stashed away in the bank or your mattress to pay off that credit card debt, there’s nothing you can do about it.
