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Your First Step Toward Financial Freedom

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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.

When debt controls you
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 (NYSE: C  ) , Bank of America (NYSE: BAC  ) , and Capital One (NYSE: 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.

When you control your debt
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.

When it's time to say goodbye
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 (NYSE: V  ) and MasterCard (NYSE: 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.

Declare victory
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.

The next step toward financial freedom is to get a strong set of investments working for you. To learn more about that, let me suggest reading The Motley Fool's special report on retirement. Inside, you'll discover some tips on putting together a smart investment portfolio, along with three time-tested stock names that could produce attractive returns over the long haul. I invite you to click here and start reading your free copy right now.

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

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.

Read/Post Comments (5) | Recommend This Article (36)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 23, 2012, at 5:25 PM, robyrob wrote:

    I don't think the disclosures had much to do with the lowering of debt. Most people already knew paying the min would make things take forever.

    The requirement that all money AFTER the minimum payment be paid towards the balance with the highest rate made a much bigger difference.

    If you had charges made @ 13% and then used one of those checks @ 5%, in the old days you had to pay off the 5% balance before you could even start paying of the 13%.

    This was a huge win in the CARD Act for consumers.

  • Report this Comment On May 23, 2012, at 6:02 PM, xetn wrote:

    You should send this to the US Department of the Treasury.

    I don't think they understand the implications of an every growing deficit.

  • Report this Comment On May 23, 2012, at 9:39 PM, julcion wrote:

    Oh you betcha, the Treasury knows us tax payers

    are slaves to the system!

  • Report this Comment On May 24, 2012, at 4:46 PM, asteist wrote:

    I was able to take quite a fine advantage of the largesse of Pursue Bank (a pseudonym for a large bank that offers the finest credit cards). the make wonderful offers of 30,000 or 40,000 and even 50,000 points for opening a credit card and spending several thousand dollars in several months. I made more than $5,000 last year charging purchases that I would have charged anyway. However, I always pay on time and they cancelled my accounts because I was "not using the credit cards the way they were intended to be used." Oh well.

  • Report this Comment On May 27, 2012, at 8:03 AM, Howch wrote:

    Before taking a brief Florida vacation, I accepted an offer from Chase "Freedom" for a 0% card, with 30,000 bonus points after 1st purchase. I charged the whole trip and received a $300 "credit" to my balance, essentially paying for half of my lodging costs. With no interest until next April, I basically am being paid by this "evil giant corporation" to use their money. The investments I am able to make in the interim may pay for the rest of the trip. If not, I will pay it all off anyway out of savings. "Freedom" indeed. As long as you are smart and prudent when using credit, it is just one weapon in the battle for financial independence.

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