Wipe Out Holiday Debt

The holidays are past, and the credit-card bills have arrived. It's time to face the music, and it isn't necessarily jolly. Households with at least one credit card spent, on average, $1,534 this past Christmas, according to CardWeb.com.

If you don't happen to have enough cash on hand to pay the entire balance, the Ghost of Christmas Past could haunt you for months or even years to come. For example, if you make just the minimum monthly payment -- $38 to start on a card with an interest rate of 16% -- you'll be paying off your balance until 2020, when you will have handed over $1,471 in total interest.

Consolidating bills via a home-equity loan or line of credit isn't a silver bullet. Even if you lower the interest rate, you'll be tempted to simply stretch out the payments. And borrowing against your home has risks you may not anticipate.

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The best solution is to bite the bullet and pay down the extra debt quickly. You may be able to lower your interest rate simply by calling your credit card issuer, or by transferring the balance to another card.

Think twice about home-equity borrowing

Transferring your credit-card balances to a less-expensive home-equity line of credit or loan is an option most financial planners discourage.

"I hear all these ads touting how home-equity borrowing will let you 'eliminate debt,'" says Glenda Moelenpah, a financial planner in San Diego. "But they really just let you change it and take on greater risk, too, because you use your home as collateral." Translation: If you can't make the payments, you could lose your home in foreclosure.

Moelenpah says sales pitches often emphasize the tax deductibility of the interest that you pay. But she points out that the law lets you deduct only the interest on "acquisition indebtedness" -- what you paid for the house -- plus $100,000 of other home-equity borrowing.

When you sell, you'll have to pay off any outstanding home-equity debt at closing. If you've borrowed more than the value of the home or if its market value has fallen, you could find yourself "upside down" -- owing the bank money at closing. That's not a happy place to be.

Because of those risks, Moelenpah says she's reluctant to advise clients to consolidate debt with home-equity borrowing unless they take steps to avoid having the same problem again next year.

If you do go that route, a home-equity loan imposes more discipline than an home-equity line of credit. With a home-equity loan, you get a lump sum and pay closing costs. The loan will require a fully amortized payment of principal and interest every month -- typically over five or ten years. Plus, rates are running a half point lower, on average (currently 8.21%), than on home-equity lines of credit, according to HSH.com.

How to pay it down fast

Rather than take on the risks of borrowing against your home to consolidate your credit card bills, consider these tips for disposing of debt from Money Management International, a nonprofit credit-counseling agency affiliated with the National Foundation for Credit Counseling:

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Track the damage. List all your creditors, how much you owe to each and the interest rates. Total it. Post it where you'll see it, and update it monthly.

Create a budget and a 90-day repayment plan. Figure out where you can cut and apply the extra funds toward your debt (see Build Your Budget for help). In the example above, you'd have to come up with $525 a month to pay off the debt in three months, and you'd pay $41 in interest. If the best you can do is $250, it will take you seven months and cost you $78 in interest.

Hide your credit cards. If you have to use credit, don't charge anything you can't repay in 90 days.

Pay strategically. Make at least the minimum payment on all your cards to avoid late charges and any sudden increases in your interest rate. Dedicate extra funds to the cards with the highest interest rates.

Reduce your interest rate

The lower your interest rate, the more your monthly payment goes to pay down the principal you owe. This might be a good time, especially if you have a good credit record, to ask creditors to lower your interest rate.

Scott Bilker, founder of DebtSmart.com, suggests letting the bank know that it will lose you as a customer if it doesn't. If they say no the first time, try again. You might score with a different customer service rep.

Or you could transfer your balance to a card offering a 0% introductory rate -- but only if you'll repay your debt fully before the rate rises.

Get ahead of the game

To avoid the specter of holiday debt next year, credit counselors recommend that you start saving now. Divide what you spent this year by 11 (February through December), and stash the result each month in a savings account.

A Christmas Club account at your bank or credit union won't pay much interest, but it will impose a penalty on any withdrawals before the holidays. If you're disciplined, you could open an account with HSBC Direct, which pays 5.1% interest, or ING Direct, which pays 4.5%.

Do you look forward to large annual income-tax refunds that you use to pay down your credit-card debt in a lump sum? Moelenpah says a better strategy is to adjust withholding downward and apply the extra monthly income to your credit-card debt.

And Moelenpah offers this "radical" approach to gift giving if you're carrying credit-card debt: "Maybe next year you can't afford to buy any gifts," she says. "Of course, that doesn't mean you can't give them." A box of homemade cookies may be more meaningful than another cashmere sweater, and you won't be paying for it for the next 20 years.