Don't Pay by Their Rules

There's only one tragedy greater than standing in your driveway at 6 a.m. on a Saturday, selling your Stair-Maestro TX5000 for $8 to an early-bird bargain hunter -- and that's to still be making credit card payments on it afterward.

That's exactly what will happen if you pay by the guidelines put forth by your purveyor of plastic, otherwise known as "Paying the Minimum Amount Due."

Rule No. 1: Always pay more than the minimum amount required. A lot more.
We Fools don't pay according to the lending industry's standard rules. Revolving credit cards (unlike charge cards from American Express, which require you to pay the full balance each month) require minimum payments as low as 1.5% to 2.5% of your outstanding balance each month -- a calculation cleverly designed to prevent you from paying off your balance before your grandkids' grandkids celebrate their bar mitzvahs.

Seriously -- if you pay by your lenders' rules, it'll take you 44 years and one month to pay down a balance of $4,500, even if you don't put another penny on the card once you reach that limit.

And how much will that $4,500 of CDs and weight-loss programs end up costing? About $17,000. If that doesn't make you drop 20 pounds, we don't know what will.

Rule No. 2: Keep your eye on the interest rate.
How come it's possible to pay off a mortgage during your lifetime, but your credit card balance can last well into the next century?

The way interest rates are calculated in the credit card business is different from those that lenders use on the mortgage side of the business. Mortgage loans are amortized over a fixed term -- say, 15 or 30 years. The term's interest rate and balance are used to calculate a fixed payment that results in the balance being paid to zero after the specified number of payments.

Credit card issuers, on the other hand, use a baffling, complex system of pulleys, ball bearings, mirrors, and Boolean algebra to calculate your finance charge. In the end, most come up with a figure somewhere between 0% and 32%.

OK, we'll get serious for a moment. Credit card debt is open-ended -- meaning there's no fixed term. Determining the terms of your loan is a numbers game for the industry. Looking at the population as a whole, the lenders set your minimum payment based on what makes them feel comfortable that you can handle the debt and won't default on your loan. Obviously, some borrowers will be unable to pay back their loans. And guess who pays for the deadbeats? That's right -- you. Credit card issuers set the rates higher for everyone so they can cover expected losses.

The interest rate is the Rosetta Stone for those trying to pay down a balance. Watch it closely. Some banks charge a "fixed" annual percentage rate, while others charge a "variable" APR, which is tied to an index, such as the prime rate. The Schumer Box, which must legally be included on every credit card solicitation, contains all of a card's vitals. If you can't figure out your card's APR by looking at your monthly statement, call the customer service number for a translation.

Rule No. 3: Pay down your credit card debt before you invest.
Bar none, the best financial decision you can make is to pay down your debt -- before you even start investing. Ask your kid, your niece, or the tyke behind you in line at the grocery store, "Which sounds better -- losing 18% of your cash a year, or making 12% on every buck you sock away?" Go ahead. We'll wait.

In fact, while we're waiting, we'll do the math for you. Take an investor who comes into a sudden $3,000 windfall. Although Jane Investor has $3,000 in debt, she's heard about the great returns she can get in the stock market -- well, at least the returns that folks got a few years ago. If an average year on the stock market pushes her holdings up 12% (we're being extremely generous here), can she beat the 18% growth rate on her debt? Nope.

A decade later, her debt has grown to more than $15,000, and her investments have grown to more than $9,000. Though she started with enough money to eliminate the debt, she's now in the hole by more than $6,000 -- until she sells those stocks. Then she'll have to pay some of the profit back to the government in capital gains taxes. So she's actually out even more.

Rule No. 4: Make every point matter.
In this instance, we think the numbers speak louder than any lavish prose we could compose. So here, in all of its glory, are the gory details of what it will take to pay down eight grand at four different interest rates, if you pay just the minimum balance each month.

Calculations based on making minimum monthly payments of 2.5% of the balance.

Just to state the obvious (we Fools occasionally do that, you know), it appears that the interest rate plays a somewhat significant role in your debt load. If you currently carry a balance, it behooves you to make sure you're paying as little interest as possible. In fact, the first place we suggest you look for a lower rate is right in your wallet. It's not always necessary to go to a new issuer to get the most competitive interest rate. Read on for ways to work out a sweet deal with your current lender.

Rule No. 5: Ask for a lower rate. Really, just ask.
If your current lender is charging you more than 12% interest, it's time to renegotiate, Fool. Persuade your lender to lower your interest rate.

Hundreds of Fools (Really! We've counted!) have used this tactic to get points knocked off their interest rates, win years of freedom from repayments, and save countless dollars in interest payments. According to a survey conducted by the U.S. Public Interest Research Group, more than half of the study's participants who called their credit card company were successful in reducing their annual interest rates by an average of one-third.

And what a difference one phone call can make: Rachel Heller, one of the 50 consumers who participated in the survey, was able to cut her APR almost in half, from 15.9% to 8.65%. Working with a balance of $4,474 and making the minimum payments of 2%, Heller saved herself $324 in just the first year and $5,031 over the life of the debt. Because of her lower APR, she will also pay off her debt almost 10 years earlier.

Why does this tactic work? One reason is that the lending industry is filled with competition. The market is saturated with credit card offers, as you might have noticed. Your lender would rather keep you as a paying customer -- albeit at a lower interest rate -- than shell out anywhere from $50 to $150 to acquire a new customer.

Use your leverage and get your lender to lower your interest rate -- and waive a few fees, while you're at it.

This tactic works best for those with decent credit ratings, a history with their current credit card company, a low unpaid balance compared to their credit limit, and no late payments in the past year. Still, even if you have a few blemishes on your record, it's clearly worth a try.

If they won't play ball -- even after a few minutes of hearing you sobbing into the receiver -- it's time to move on and find a better offer. But again, read the rule book before you tread into teaser-rate territory.

In matters of credit management, it nearly always pays to pull out all the stops and set your own rules.