A surprising new financial trend is taking over the country. In recent months, households have seen significant reductions in credit card debt. Could this be a sign that American consumers are saving more, buying less, and managing their personal finance more responsibly?
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Possibly. A big part of the story points to something more troubling, however. Credit card issuers have reported that their charge-offs have increased sharply. If consumers have less debt now, it is at least partially due to an increase in defaults. Borrowers, due to a variety of circumstances, can’t pay back the debt they accrued. With continued, extended high rates of unemployment, borrowers are delinquent more often, and some credit cards will consider an account to be in default after just one missed payment.
The results of being in default are harmful in the short-term and the long-term.
For many families today, it is too late to avoid default. With just one missing payment, consumers will have to deal with late fees and high interest rates, and it won't be long until the credit card companies close your account and turn collection responsibilities to other companies that will stop at very little to get you to pay. If your family is heading down this road without attracting trouble yet, here are three tips for avoiding credit card defaults.
1. Increase your emergency fund. The traditional advice calls for families to hold three to six months' worth of expenses in an accessible savings account. That rule of thumb doesn't cut it in a tough economy. The right size for an emergency fund depends on your family's needs, your job security, your flexibility to adapt, and even the economy.
If you're already having financial difficulty, bulking up the emergency fund might seem like an impossible task. The cash cushion is necessary, however, so save what you can.
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2. Call the credit card company and pay something—anything. If you can't make your minimum payment on time, don't just put your head in the sand and hope the bill will go away. The credit card issuers would rather work with you than with debt collection agencies, so you have room to negotiate. Call the number on the back of the card and talk to a representative about changing your payment plan to something you can afford. If you've lost your job or are experiencing some other hardship that is preventing you from paying your debt, the issuers have options for you.
3. Spend responsibly. Use your credit card to buy only what you can cover with cash. If you're counting on future income to cover your credit card payments, you're transferring control of your finances to the issuer and taking unnecessary risk. Even if your financial hardship is caused by forces beyond your control, holding onto a solid spending philosophy during the good times will help you deal with unplanned financial problems.
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With a healthy emergency fund, a payment plan you can handle, and credit card charges within your level of income, you will be in a much better position for handling loss of income. Otherwise, these problems could lead to the inability to pay your credit card bill. That situation results in fees, higher interest rates, calls from debt collection agencies, the destruction of your credit worthiness, and even wage garnishment. With smart choices, these troubles can be avoided or minimized.
Luke Landes writes for Consumerism Commentary, where he encourages discussions about money and consumer issues. Consumerism Commentary regularly tracks and reviews the best online savings accounts and other financial products.