Most Americans will face a nice little dilemma in 2018. Thanks to tax cuts, we are going to take home more of our paycheck.
But what should we do with that extra cash?
If you use credit cards, finding the answer is a lot easier than executing it, so allow us to drive it home: PAY DOWN YOUR CREDIT CARD DEBT!!!!
That won’t be nearly as much fun as feasting at the Cheesecake Factory or buying the latest Air Jordans, but it is the best way to escape the financial black hole millions of Americans have been sucked into by overindulging in “wants’ with a credit card.
Credit card debt hit an all-time high of $1.021 trillion in 2017, according to the Federal Reserve. It’s been growing almost 5% a year as America has crawled out of the Great Recession and back into credit card debt.
It’s no coincidence that lenders have eased qualification standards so you’re credit limits probably have gone up, even if your ability to pay it off hasn’t. The average household that uses credit cards owes $15,624 to Visa, American Express, Discover and the Wawa/JCPenny/Costco credit cards that don’t require much more than a legible signature to get .
If only there weren’t such a thing as “interest,” that wouldn’t be problem.
Unfortunately, interest has been around since the first caveman loaned his neighbor a couple of shiny rocks to go buy some new loincloths. It’s a fact of financial life that lenders charge borrowers for their money and if you fall behind even a little, they charge even more.
The average household now pays $900 a year for the privilege of borrowing money by using a credit card. There’s nothing wrong with that, but it puts the onus on the borrower to pay back the money before interest charges kick in and turn that practical $76 blouse into a $97 extravagance.
Seventy-six dollars is useful metric because that’s how much extra per month middle-class Americans will be taking home in 2018, according to the Tax Policy Center.
By middle class, we mean people who earn between $48,000 and $86,000 a year. It works out to roughly $1,000 more a year, all thanks to the sweeping tax bill Congress passed just before Christmas.
It’s the biggest overhaul of the U.S. tax system in 30 years and came after the usual partisan political bickering over corporate vs. individual cuts and whether it will truly benefit Joe or Jane Plumber.
Whatever your opinion, the laws of mathematics say an extra $1,000 a year is still an extra $1,000 a year. And while that’s the tax savings for the middle class, the Tax Policy Center said the average savings for all Americans will be $2,140.
It will be coming soon to a paycheck near you.
“Use of the new 2018 withholding guidelines will allow taxpayers to begin seeing changes in their paychecks as early as February,” according to an Internal Revenue Service report.
If you already bought an iPod with your new-found wealth, please crunch the following numbers.
As mentioned above, the average household that used credit cards owes $15,624. The average interest rate is 16.15%. That translates into $2,523 paid a year IN INTEREST!
In other words, the average household is sending $210 a month to a credit card company and getting nothing tangible in return.
Think of what else you could spend $2,523 on (95 gallons of gas, 53 Big Macs, 28 matinee movie tickets at AMC theaters, two 16-ounce ribeye dinners at Morton’s Steak House, one-third of a prime ticket to a Taylor Swift concert, etc.).
Doesn’t it make more sense to pay down as much of the balance as possible before adding to your credit card debt?
If you’re still not swayed, consider this. If the average U.S. household is allocating $400 a month toward the average credit card debt of $15,624, it will take 56 months to pay it off and cost $6,694 in interest.
And that’s only if you stop using the credit card!
If that middle-class household devoted its $1,000 tax cut paying off credit cards, the bill would be paid in 44 months and cost $5,071 in interest.
That’s a $1,623 savings in interest. And that’s just for those making between $48,000 and $80,000 a year. Now consider the average tax cut of $2,140 annually
If you owed $15,624 in credit and were paying $400 a month toward that debt, then added your tax cut ($178 a month), you would pay it off 22 months sooner and save $2,751.
Doesn’t that make more sense than spending your tax cut on Taylor Swift tickets, especially if you charge them and are sucked deeper into the credit card black hole?
You should also be aware that interest rates are likely to rise. The Federal Reserve increased borrowing rates five times since 2016. More increases are expected in 2018, and the cost will be paid by consumers. Analysts say the average household could pay an additional $100 a year in interest.
So, what should you do with your tax break if you’re not the average household and don’t carry a heavy credit-card load?
First, pat yourself on the back. Then check to make sure you have an adequate emergency fund. Ideally, you should have enough stored away to cover six months of living expenses. Failing that, try for three months.
Unfortunately, 57 million American had a grand total of $0 in emergency funds in 2017, according to a Bankrate.com survey. As tight as your budget may be, you should try to allocate at least part of your tax cut to emergencies.
You could set up direct deposit from your paycheck into a savings account. That $76 a month would eventually (and painlessly) add up to a decent emergency fund.
That gets to the root of most financial problems: a lack of planning and budget discipline. The fact is some people just aren’t good at money management, and those people are most at risk of squandering their tax cut.
The tax cuts will make those goals easier to reach. So, when you see them reflected in your take-home pay, resist the temptation to buy something new. Pay off something old, namely your credit cards.
You’ll enjoy those Big Macs a lot more knowing they won’t eventually cost you as much a steak dinner from Morton’s.
Bill “No Pay” Fay has lived a meager financial existence his entire life. He started writing/bragging about it in 2012, helping birth Debt.org into existence as the site’s original “Frugal Man.” Prior to that, he spent more than 30 years covering the high finance world of college and professional sports for major publications, including the Associated Press, New York Times and Sports Illustrated. His interest in sports has waned some, but he is as passionate as ever about not reaching for his wallet. Bill can be reached at [email protected].
- NA, ND. Analysis of the Tax Cuts and Jobs Act. Retrieved from http://www.taxpolicycenter.org/feature/analysis-tax-cuts-and-jobs-act
- Borak, D. 2017 December 12. Fed expected to lift rates as Yellen delivers final press conference. Retrieved from http://money.cnn.com/2017/12/12/news/economy/federal-reserve-yellen/index.html?iid=EL
- El Issa, E. ND. 2017 American Household Credit Card Debt Study. Retrieved from https://www.nerdwallet.com/blog/average-credit-card-debt-household/