Your First Step Toward Financial Freedom


Debt is a double-edged sword. Used prudently -- and carefully -- it can enable you to do things you would otherwise never be able to do. But when you rely on debt, you lose your financial freedom and become a slave to a huge array of economic factors over which you have little or no control. In today's fast-changing global economy, that's not a situation you ever want to be in.

Millions of U.S. households still feel the impact of the recession from a few years ago. According to a recent survey from Demos, 40% of low-income and middle-income households paid for food, utilities, rent, and other basic living expenses using a credit card because they didn't have enough cash available. Moreover, for those who've lost their jobs, credit cards have become the funding source of last resort for basic survival, with the survey finding that 86% of households with unemployment-related expenses took on credit card debt.

Even more affluent borrowers can end up in the downward spiral that debt can cause. Despite low interest rates, issuers Citigroup (NYS: C) , Bank of America (NYS: BAC) , and Capital One (NYS: COF) still enjoy wide spreads on the amount of interest they charge on card debt versus what they pay depositors. Although those issuers inevitably lose some money to borrowers who can't repay their debts, delinquencies have fallen considerably since the height of the financial crisis. Meanwhile, with finance charges that make up a big portion of monthly minimum payments, big card debts can take years to repay.

Clearly, the answer is to do everything you possibly can to avoid the downward debt spiral. Even among those in the worst financial condition, the news on that front isn't entirely bad. Demos says that average card debt outstanding among low- and middle-income households fell by more than a quarter since 2008 to $7,145.

In addition, credit card reform laws enacted a few years ago appear to be partially responsible for debt reduction. A third of households are paying off their debt faster because of the disclosures that card companies now have to make on statements. Meanwhile, the proportion of people paying late fees has fallen from around 50% four years ago to 28%, and almost a quarter fewer households that did make a late payment suffered higher interest rates as a result.

Even with the tide potentially turning, credit card debt is one of the worst financing options you have. In most cases, if you have substantial card debt, your one and only priority should be to get it paid down. Only then can you be in control.

Once you've established your supremacy over your credit cards, the tables turn. Suddenly, card issuers want to offer you big rewards for using your cards, while card network operators Visa (NYS: V) and MasterCard (NYS: MA) trumpet the value of their ubiquitous presence as an easier way to manage your finances -- all the while producing fee income for themselves.

If you're disciplined, then taking advantage of the largesse of card issuers can be both profitable and satisfying. But the one thing you can never forget is that no matter how big the rewards may be, card companies expect to earn a profit from their actions in the end. Until you figure out exactly what's involved in any credit card offer, you should assume that there's a catch somewhere that will be more profitable for the card company than it is for you.

Getting a grip on your credit card debt is your first step toward financial freedom. Getting out of debt can be a long and hard road to follow, but in the end, you'll find the journey well worth the effort.

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Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance. You can follow him on Twitter@DanCaplinger.

At the time thisarticle was published Fool contributor Dan Caplinger lives free or dies. He doesn't shares of the companies mentioned in this article. The Motley Fool owns shares of MasterCard, Citigroup, and Bank of America. Motley Fool newsletter services have recommended buying shares of Visa. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy gives you credit for doing the right thing.

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