How to Pay Off Credit Card Debt: A Step-by-Step Guide
Credit card debt is one of the most pernicious financial problems. Tackling it successfully can be difficult, but it’s far from impossible. A great way to pay off credit card debt is to follow this step-by-step guide: (1) assess your situation, (2) negotiate lower rates, (3) consider a consolidation or balance transfer, (4) ) have a goal, (5) spend less and/or earn more, (6) follow something like the “snowball” strategy, and (7) succeed.
Here’s an overview of why you shouldn’t just make minimum payments, followed by a path to paying off credit card debt.
Pay attention to minimum payments
You need to understand how bad an idea it is to only make small or minimal payments. It may seem like the easiest way to gradually pay down your debt, but it’s not. Imagine, for example, that you owe $20,000 on your credit card(s) and you are charged an interest rate of 25%. (That 25% may sound extremely high, and it is, but it’s also a common rate. Many cards increase your interest rate between 25% and 30% if you’re late with a payment and it’s easy to be late when you owe a lot.) If your minimum payments are 3% of your balance, you’ll start paying a whopping $600 a month, which means you’ll need to come up with $150 a week . If you can’t, your balance will increase, putting you in even more debt.
But let’s say you do make this payment of $600 and all future payments of 3%. How effective will it be? Well, according to a calculator from Bankrate.com, it will take over 30 years to pay off the debt, and your total payments will exceed $63,000, all for a balance owing of $20,000.
Minimum payments are better for banks, not debtors. It’s much more financially sound to do maximum Payments. Here are some steps that can help you do that.
Step 1: Assess your situation
First, assess your debt situation. Get a piece of paper and your credit card statements. List all of your balances owing and the interest rates associated with each debt. Also add any other debt to get a complete picture of your debt situation. (Not all debt is problematic, of course. It can be hard to avoid taking out a mortgage if you want to buy a house, and these days mortgages are available at near rock bottom rates.)
Also get copies of your credit reports and check them for errors. By law, we are all entitled to a free copy of our credit report each year from each of the three major credit reporting agencies — visit AnnualCreditReport.com to order yours.
Step 2: Negotiate lower rates
A key help in paying off your debt is to lower your interest rate(s). The review of minimum payments above shows how difficult it is to move forward if your debt is growing at a faster rate than you can pay it off.
It is underestimated how much it is possible to get a lower interest rate on your debt – just by asking. According to a recent report by CreditCards.com, 69% of cardholders who asked for a lower interest rate got one. Of course, obtaining a lower rate is not guaranteed. The answer you will get might be no. If so, you still have other options.
Step 3: Consider consolidation and/or balance transfers
It is not necessary to consolidate your debts and/or transferring outstanding balances to credit cards with more favorable terms, but this can be an effective tactic in your fight against debt. You can check out student loan consolidation at studentloans.gov, and many people consolidate debt by transferring balances from multiple credit cards to a new card with better terms.
Be careful choosing this best card, though. Understand that balance transfer credit cards vary in many ways. Each will tempt you with an ultra-low initial interest rate – usually 0%. This interest rate will be in effect between 6 and 21 months, after which a more standard interest rate applies. This standard rate won’t necessarily be great, so you should look for cards with relatively low interest rates past your interest rate period. Better yet, simply have your debt paid off during this time. Note that your credit score will likely influence the interest rate you will be granted after the 0% rate expires.
Most balance transfer cards will also charge a balance transfer fee. It will usually be around 3% to 5% of the amount you transfer or $5 to $10, whichever is greater. So if you transfer $20,000 of debt and pay a 4% balance transfer fee, it will cost you $800. That’s a lot, but that strength worth it – if, for example, you previously paid, say, 17% or more on the card.
Examine the fine print of any balance transfer card you are considering to find out what your credit limit will be with the card. Often, you won’t be able to find out until you’ve been approved for the card. You won’t be able to transfer more than this limit (minus the balance transfer fee, if there is one), and if you go over the limit, you may have to pay a fee. Also find out if there is an APR penalty. This is when the card company raises your interest rate up to 25% or even 30% if you pay a late bill or commit some other transgression. Many cards don’t have them, and that’s preferable.
Step 4: Have a goal
During this process, you will want to develop a main goal and perhaps some smaller goals as well. For example, you may have assessed your situation and found that you owe $25,000 in credit card debt. If so, you could set a goal of paying it back in three years. (Choose a very specific time frame, so you can work towards the goal and mark your progress.) You can also set sub-goals, like having a quarter and then half paid by certain dates. Write down your goals and post them where you will see them.
Step 5: Spend less and/or earn more
Next comes some of the hardest work involved in paying off credit card debt – in fact, paying it off. To do this, you will have to devote many dollars to the cause. You can get part of it by spending less and part of it by bringing in more money. Here are some suggestions:
- Spend less by packing your lunches in brown bags and brewing your own coffee in the morning. Consider cutting the cable cord and streaming your entertainment instead. Cut subscriptions such as gym memberships and eat more at home instead of dining out. Invite friends over to play board games or watch movies instead of going to bars or shows. This all might sound less fun, but you’re tackling a tough project and you need to be aggressive about it. The longer you take, the more money you will burn in interest. Writing a new budget to control your spending is also helpful.
- Earn more money by taking a part-time job if you can. Working 10 extra hours a week for a year at $12 an hour can generate $6,000 before taxes. Possible jobs include those at local retailers as well as working from home, perhaps tutoring students or teaching music or a language. You can do freelance writing, editing, graphic design, or consulting. Think of all the things you could sell. If your household has two nice cars, can you sell one and be happy with the other for a while? Could you sell one or both and replace them with one or two less expensive vehicles? Are there items in your basement or garage that you could sell? Depending on where you live, you may be able to rent a parking space or space in your home through Airbnb, but be sure to check local ordinances first.
Step 6: Follow a Strategy
Determine the strategy you will use in your plan. One school of thought suggests the “snowball” approach, where you pay off your smallest debt first, so you feel momentum. Another approach is more rational and less emotional: pay off the debts with the highest interest rates first in order to minimize your interest costs.
Step 7: Stick to it and succeed
Finally, the last step in your debt reduction plan should be this: Succeed!
It can be hard to believe that you will ever get out of debt, especially if your debt is huge, but know that many people have successfully repaid over $100,000 in debt. It’s not always easy, but it’s very possible, and it will make you much stronger financially, with better credit and the ability to save for retirement and achieve other financial goals.