Last year, credit card debt in America surged by approximately $71 billion to $917.7 billion, according to a new study from CardHub.
That’s insane! Let me put that in perspective for you. It means that Americans have more credit card debt than the value of the entire annual economies of 176 of the world’s 191 countries.
So how does this happen? Shockingly poor consumer spending habits. According to NerdWallet, 37 percent of American households have credit card debt and the average amount they owe is $15,700.
Are you in this situation and want to learn how to pay off credit card debt fast? If so, keep reading and I will show you, in this article, how to eliminate debt easily!
The Sad Truth & How To Pay Off Credit Card Debt Fast
The sad truth is that if these households only make the standard 2% minimum monthly payments on their outstanding balances, it will take them over 43 years to pay off their debt. And that’s assuming they make no new purchases. It will take them much longer if they continue to make new purchases.
If that isn’t crazy enough, the $15,700 in debt these households have racked up on their credit cards will end up costing them $39,677 by the time they pay it all off (assuming they make 2% minimum monthly payments and are charged an average credit card interest rate of 14.62%).
That’s right! These families will end up paying almost $25,000 in interest in addition to the original $15,700 they borrowed. That’s 252% of the original amount they borrowed.
And remember, that’s assuming no new purchases and a conservative interest rate of 14.62%. Many credit cards have an interest rate over 18% and almost every family who has racked up this much high-interest credit card debt would likely continue to max out their credit cards.
It’s absolutely absurd! It means that all those $100 restaurant meals and shopping excursions actually end up costing $252 by the time they’re paid off.
How can someone end up paying 252% of their original purchases? Well, between compounding interest and taking several years to pay off your debt, a 14.62% interest rate can quickly multiply into a larger interest rate because you’re paying 14.62% interest on your outstanding balance every year.
This is the reason why credit card companies are making billions of dollars a year at the mercy of consumers who don’t pay off their credit cards in full each month. It’s also the reason why credit card debt is the worst kind of debt you can have besides payday loan debt.
What does this mean if you find yourself in this position? It means you will likely never get out of credit card debt unless you go bankrupt or get serious about becoming debt free.
But Wait! What if I told you that I can show you a system that will teach you how to pay off your credit card debt fast?
Sound too good to be true? Well it’s not, and that’s exactly what I’m going to show you in this article – a 5 step system that will teach you how to pay off your credit card debt and become debt free. And it’s easier than you think, as long as you’re willing to show some self-discipline and get serious about becoming debt free.
Step 1: Determine Your Current Financial Situation
Before you can develop a plan to pay off your credit card debt you need to first determine:
a) How much money you are earning each month (monthly income)
b) How much money you are spending each month (monthly expenses)
c) Your monthly surplus or deficit (monthly income – monthly expenses)
d) How much debt you have (add up all your debts ex: car loan balance, credit card balance etc.)
You can determine the above information one of two ways:
The Easy Way – Mint.com
While you could do this the hard way by pulling out a pen and a piece of paper (or by using a computer worksheet), I highly recommend signing up for the free service at Mint.com.
Mint.com is a free, web-based personal financial management service available to both Americans and Canadians. It allows you to easily obtain an accurate snapshot of your current financial picture. It will also save you some serious time as it automatically tracks and categorizes all of your monthly spending so you don’t have to.
Click here to open a free Mint.com account and follow the step by step guide to connect all of your bank, credit card, loan, and investment accounts. Within minutes you’ll know your net worth, total debt and Mint will start tracking all of your future monthly income and expenses. Within 30 days you’ll have a full month of non-cash income and expense data in your account that Mint will help you to analyze.
Note: While Mint can track cash withdrawals, it can’t read your mind and it can’t determine what you do with the cash that you withdraw so start keeping the receipts for all of your cash purchases. Then, at the end of the month, you can determine what you bought with cash and categorize those cash expenses accordingly.
The Hard Way – Pen & Paper
You can also determine your monthly income by manually adding up all of your sources of income for the month. You can usually find this information on your employee pay stubs or through employer direct deposits into your bank account.
Determining your monthly expenses is a bit more difficult. In the perfect world, you will have kept the receipts of every purchase you made during the last month and you can just total those up to determine your monthly expenses. However, chances are this is not the case.
Alternatively, if you don’t make many cash purchases, you can go through your bank account and credit card statements to determine all of your non-cash purchases and obtain a pretty accurate picture of your monthly expenses.
Worst case scenario, you make a lot of cash purchases and have no receipts. In this case, start keeping the receipts for all of your future cash purchases. In one month’s time, you can determine your total monthly expenses by going through your cash purchase receipts, your bank, and your credit card statements.
When determining your monthly income and expenses make a list detailing every source of income and every expense. You will use this itemized breakdown in future steps.
When determining your total debt, list all of your debts in order of highest interest rate. For example, if you have a credit card balance of $5000 and your credit card interest rate is 18.9% you would list your credit card debt above your mortgage debt if your mortgage has an interest rate below 18.9%.
Step 2: Control Expenses By Creating A Budget
Once you have figured out your monthly income and expenses, calculated your monthly surplus or deficit, and have determined your total debt, it’s time to begin creating a budget. The purpose of a budget is so you can control your future spending in order to free up money to pay off your outstanding debt.
Don’t let the word “budget” intimidate you. Call it a spending plan if you prefer. It will guide you to success if you follow it’s lead. Plus, you’re already halfway to successfully creating a budget. It’s way easier than you think.
In you budget, you get to decide how much of your monthly income you’re going to spend and how much you’re going to put towards paying off your debt. This is where you have to exercise self-discipline as you will have some tough decisions to make in order to lower your monthly expenses.
Keep your debt-free goal in mind when making these choices. Your immediate goal in this step is to get your monthly expenses below your monthly income.
Create A List of Your Monthly Expenses
Regardless if you are preparing your budget using Mint.com or by hand, make a list of all of your monthly expenses. If you completed step 1 by hand you should already have this list. If you used Mint and it has been less than 30 days either wait 30 days so you have a full month of data, or manually record your last 30 days of expenses from your bank and credit card statements.
When making the list separate your obligatory expenses such as mortgage / rent, utilities, supermarket food, minimum monthly loan/credit card payments etc. from your non-obligatory expenses.
Non-obligatory expenses include all optional spending such as shopping, entertainment, eating out, travel etc. Non-obligatory expenses can also include gateway expenses which are expenses that create many more expenses.
Homes and vehicles are examples of gateway expenses. If you rented rather than owned a home you wouldn’t have to pay property taxes, home insurance would be less, you wouldn’t have mortgage payments, nor would you have any house upkeep expenses.
The same holds true for owning a vehicle. If you walk, bike, use public transit, or utilize a car sharing service you wouldn’t need car insurance, nor would you have any fuel expenses, vehicle maintenance costs, or vehicle depreciation costs.
One of the most effective ways you can drastically lower your monthly expenses is to eliminate one or multiple gateway expenses. It all comes down to how much debt you have and how badly you want to become debt-free. The more you want to become debt free, the faster it will happen.
Create Expense Categories
Once you have all of your obligatory and non-obligatory expenses listed, you’ll want to group similar expenses into categories (if you haven’t done so already).
For example, if you ate out at a restaurant 10 times during the month group together all 10 restaurant bills under one expense category called “eating out.” If the 10 outings cost $500 then record that amount under the “eating out” expense category.
To give you an idea of the expense categories you can create, I allocate monthly amounts to the following categories:
- Obligatory home (i.e. mortgage/rent, home insurance, utilities)
- Optional home (i.e. home improvement, home furnishings)
- Vehicle (i.e. fuel, maintenance, insurance, tolls, parking, car loan)
- Entertainment (i.e. movies, music, arts)
- Personal care (i.e. hair, hygiene products, spa)
- Health and fitness (i.e. doctor, dentist, health insurance, gym membership)
- Shopping (i.e. clothing, hobbies, electronics)
- Supermarket food
- Eating out
- Other spending
- You could also add a kids or pets category if you have kids or pets.
If you are using Mint.com to create your budget, they list many of the above expense categories. You can click on the “Budget” heading in your Mint account and easily set up your budget expense categories even if you don’t yet have any expense data in your account. If you require any additional guidance they have step-by-step instructions on their website.
Note: You should note that I included “entertainment” and “eating out” categories. I’m a believer that you should create a budget that you can stick to over the long-term, not a fad budget.
It’s highly likely that if you cut expenses to the point where you never reward or treat yourself you will not be able to maintain enough motivation to stick to your budget over the long-term. Instead, you need to adopt a fiscally responsible lifestyle that is sustainable over the long-term.
It’s the same concept as staying physically fit. Diets are notorious for being short-term and ineffective. Instead, it’s much more effective to adopt a healthy lifestyle that is sustainable over the long-term.
Once you have your expenses categorized, you need to decide in which expense categories you are willing to reduce your spending. Significantly reducing your spending in non-obligatory expense categories such as “Entertainment” and “Shopping” is usually a good starting point.
Keep reducing your spending in expense categories until your monthly expenses are below your monthly income. As long as your monthly expenses are higher than your monthly income your debt will continue to increase.
I know I need to get my monthly expenses below my monthly income, but by how much?
Not only do you want to get your monthly expenses below your monthly income but you also want to include a buffer that you are going to use to pay off your high-interest credit card debt faster. You don’t want to only be making the minimum monthly payments on your credit card.
Whether you cut your monthly expenses so they are $50 or $500 less than your monthly income is a decision you have to make, but don’t get too caught up on the amount of the buffer right now. You can always adjust it in the coming months when you refine your budget.
It comes down to how badly and how quickly you want to become debt-free. Remember that $100 restaurant meal or shopping excursion I spoke about at the beginning of this article? Do you want it to end up costing you double or triple down the road due to interest costs, or should you stay home and put the money towards past restaurant meals and shopping excursions that you haven’t yet paid off?
Remember, the lower your monthly expenses, the faster you’ll be able to pay off your debt.
Running out of expenses to cut?
Not once when someone has told me that they have run out of areas to cut expenses have I not been able to find further savings. Often you just need another set of eyes to look at your budget from a different perspective to find additional savings. Try getting a friend or coworker to look for additional areas of savings once you feel you have run out of expenses to cut.
Also, don’t think your obligatory expenses can’t be reduced. You can always use less electricity, spend less on food, negotiate better rent/mortgage rates, or downsize.
Check out the article 7 Money-Saving Hacks That Can Save You $10,000+ A Year to discover additional ways to save money.
Should I contribute to an emergency fund or savings plan?
Some people have asked if they should contribute each month to an emergency fund. I use my line of credit as my emergency fund so it doesn’t tie up cash that I can invest. I reserve it for this purpose and rarely use it for everyday spending.
I highly recommend an emergency fund through either a line of credit or a cash reserve but, if you have high-interest credit card debt you should use any extra money or credit line room to eliminate your credit card debt before you start building an emergency fund.
I’ve also been asked if you should regularly contribute to some type of savings plan. These plans take on several looks and can include college or university education funds for your children or retirement savings plans for yourself. While I recommend that people without high-interest debt regularly contribute to savings plans, this is money that could help you pay down your high-interest debt faster.
It’s highly likely that the money you will save by paying down your high-interest debt faster will be substantially more than the profits you will earn by placing the money in a savings plan. Over the long-term, this will result in you paying less interest which means you will eventually have even more money to invest in a savings plan. This is why you should strongly consider suspending any investments in savings plans until you have your high-interest debt paid off.
Step 3: Lower Your Interest Rates
One of the keys to paying off your debt fast is to get the lowest interest rates possible because the less interest you pay, the faster you can pay off the principal amount. This strategy could easily save you $1000 or more in interest savings every year for every $15,000 in outstanding debt.
You have a few options for getting a lower interest rate. These options are not listed in order of importance so you should consider each option and choose the one(s) that make the most financial sense for your situation.
With all of these options, if you can’t consolidate or transfer all of your debt to lower interest rate alternatives, transfer your debt with the highest interest rate first, your debt with the second highest interest rate second, and so on.
For example, let’s say you have $10,000 of debt on a Visa card with an interest rate of 22.5% and $8000 of debt on a MasterCard with an interest rate of 18.9%. If you get approved for a 12 month 0% balance transfer with a $15,000 limit you want to transfer the $10,000 of debt from the Visa card since it has the higher interest rate and then $4500 of debt from the MasterCard. I explain below why I only transferred $14,500 of debt rather than $15,000 of debt.
Option 1: Credit Card Balance Transfer (or Multiple Balance Transfers)
If your credit score is good (about 675 or above) you are in good shape to save big on interest with a credit card balance transfer. If you don’t know what your credit score is, American’s can find out their credit score for free through their Mint.com account or through Credit Karma.
Unfortunately, Canadians aren’t so lucky. While Canadians can get a free credit report from Equifax, the free report does not include your credit score. If you want your credit score you will have to pay $11.95.
If you have a good enough credit score you might be able to get a 0% balance transfer offer. Even if you don’t get approved for an amount equal to the level of your outstanding debt, paying 0% interest instead of 18.9% interest on any amount will help you to pay off your debt faster.
3 rules to follow when using credit card balance transfers
Below you will find links to the best 0% credit card balance transfer offers. However, there are a few very important rules you need to follow to make this strategy work.
Rule #1: Be sure to read the fine print. Many credit cards have a poorly advertised 1-2% balance transfer fee. Most also have a clause that will cause your promotional rate to bump up to 5%+ if you’re late making a payment or if you miss a payment. So, it’s very important that you’re on time with all of your payments. Even with the 1-2% balance transfer fee, the savings from the lower interest rate will usually be greater than the cost of the balance transfer fee. Just be sure to factor in the balance transfer fee if one exists when considering this option.
Rule #2: Do not under any circumstance use this credit card to make any purchases. If you charge any expenses to this card those purchases will be assigned the normal credit card interest rate (usually at least 18%). Furthermore, any payments you make will go towards paying off the 0% interest debt first rather than the purchases. This will result in you accumulating more high-interest debt – exactly the opposite of what you’re trying to achieve.
Rule #3: Mark on your calendar when the 0% promotional rate offer will expire. At the end of the offer expiry if you haven’t paid the balance off in full you will begin to accrue interest at the normal credit card interest rate. If you still have an outstanding balance you will want to pay that off just before the expiry of the promotional rate offer. Where do you get the money to pay off the outstanding balance?
One strategy I have successfully used in the past was to transfer my outstanding balance at the end of the 0% promotional rate offer to another credit card with a similar 0% promotional rate offer. Before relying on this strategy make sure to read the fine print as some banks will not allow you to transfer a balance from one credit card to another if they have issued both cards.
If you plan on using this strategy it’s a good idea to make sure a different bank issues the credit card to which you will be transferring the balance. Alternatively, you can transfer the outstanding balance to a line of credit or bank loan.
Rule #4: If you are approved for a 0% promotional rate offer with a $15,000 limit, don’t transfer $15,000 in debt. You always want to leave at least a few hundred dollars of room for unanticipated charges because if you go over your $15,000 limit you will likely have breached the promotional offer terms and it could cause your 0% interest rate to increase significantly. Instead, leave a buffer and only transfer $14,500 of debt.
What do I mean by unanticipated charges? These could include a one-time upfront balance transfer fee of 1-2% or other miscellaneous fees that you could learn about by reading the terms and conditions of the promotional rate offer your select.
Option 2: Obtain A Credit Line Or Personal Loan
You should consider a credit line or personal loan but be aware that different lenders often offer you significantly different rates.
Generally, personal loan rates run anywhere from 10-20%, but you can sometimes find one with a rate as low as 5-6% if you have a good credit score. Also, similar to how credit card companies offer introductory promotional rate offers to attract new customers, banks do the same thing and offer new customers introductory promotional rate offers on loans and lines of credit.
I’ve had a bank where I was a long time customer tell me the best rate they could offer me on a line of credit was 11%. Meanwhile, the bank across the street where I had never been a customer offered me a line of credit with a 5% rate. This is why you should shop around and get rate quotes from a few different lenders.
Even if you cannot get a rate below 10%, moving a large amount of money from a credit card with an interest rate above 18% to a personal loan / line of credit around 10% is still a great deal because you’re effectively cutting your interest charges in half.
In addition to brick and mortar banks, consider borrowing money to pay off your debt from non-traditional lenders such as a peer-to-peer lender. While peer-to-peer lending is not readily available to Canadians due to government regulations, it is available to Americans. A few examples of peer-to-peer lenders are LendingClub.com and Prosper.com.
Option 3: Ask Your Creditors For Lower Interest Rates
Often a simple telephone call to your credit card issuer is all that it takes to get a reduced interest rate. Several people have shared stories with me where they got their credit card interest rates reduced by a few percentage points just by asking. This can add up to hundreds of dollars in annual interest savings. It also helps if you have a good credit score and if you’ve been a long time customer who always makes their payments on time.
Another thing that you can try is to call your credit card issuer and tell the customer-service representative that you have been offered a lower interest rate by another credit card issuer. Tell them that you’re considering taking your business to their competitor if they cannot match the offer. Most credit card issuers have customer retention departments that can offer you deep rate discounts and waive annual fees to retain your business if they think you’re going to leave.
Note: While any bank can offer their customers a branded Visa or MasterCard, American Express issues all its credit cards personally. So don’t call up American Express and tell them that you’ve been offered a better interest rate on an American Express card by another bank because they’ll know you’re bluffing. Instead, say you’ve been offered a better rate on a Visa or MasterCard and are considering making the switch.
Option 4: Refinance Your Mortgage
If you own your home you may have built up enough equity through paying down your mortgage that you can consolidate all of your debt into your mortgage. Even if you don’t have much equity in your home this option may still be possible. It’s worth talking to your mortgage professional so they can explain the terms and conditions of your current mortgage and help you to determine if you can consolidate debt into your mortgage.
I wouldn’t normally recommend refinancing your mortgage since repeatedly using your home to borrow money could lead to you reaching retirement age broke. However, with mortgage rates at all-time lows you should consider consolidating your debt into your mortgage as you will pay around 3% interest instead of the 18% interest you’d pay if you left the debt on your credit card.
The key to using this strategy successfully is to not consider yourself having eliminated bad debt once you have consolidated your outstanding debt into your mortgage. Don’t abandon the advice in this article and go back to the habits that got you into debt in the first place, because you’ll end up in the same position in the future. Instead, continue to aggressively reduce your spending so you can build up a sizeable nest egg and pay off your mortgage faster or invest in some form of savings plan.
One warning: I don’t recommend you make a decision on the spot in your mortgage lender’s office. Your lender has a vested interest in getting you to choose this consolidation option even if it’s not the best option for your situation. Get the lender to write the numbers down on a piece of paper so that you can go home and compare the costs of this option with your other options. Remember to factor in the cost of additional mortgage insurance if it’s required. Your lender can tell you if you require additional mortgage insurance.
Step 4: Prioritize And Pay Off Your Debt
Once you have fully explored your lower interest rate alternatives and have selected one or a combination of options, it’s time to put your plan into action.
In Step 1 you made a list of all your debt and sorted it by interest rate. The debt with the highest interest rate was at the top of your list and the debt with the lowest interest rate was at the bottom of your list. If you were able to successfully transfer some or all of your debt to lower interest rate alternatives (as presented in Step 3), you need to redo this list.
Just like in Step 1, the debt with the highest interest rate should be at the top of your list and this is what you’ll focus on paying off first. Your complete focus will be on getting rid of the debt at the top of your list. Every spare dollar you can squeeze out of your monthly budget will go towards paying down this debt. You’ll make the minimum monthly payments on all of the other sources of debt on your list until you eliminate this list-topping debt.
Once you pay off the debt at the top of your list you’ll use the same method to pay off the next highest interest rate debt on your list. Once again your entire focus will be on this debt and you’ll make the minimum payments on all of the other sources of debt on your list. You’ll continue to repeat this process until you’ve eliminated all of your debt and become debt free.
Step 5. Stay Motivated By Setting Goals And Tracking Your Progress
To ensure that you stay on track with your budget you need to set specific goals. Setting specific goals helps to keep you focused on your end goal – becoming debt free.
Among other options, your specific goals could be time and amount specific. For example, you could set specific goals that by June 30th you will have reduced your debt to $12000, by December 31st you will have reduced your debt to $6000, and by June 30th of the following year you will be debt free.
The key is to set several smaller, realistically obtainable goals that are not too lofty so you will experience a boost of motivation each time you successfully reach one of them. The boost of motivation that you will experience will then propel you forward towards reaching your next goal. And don’t forget to celebrate and reward yourself when you achieve a goal. This is important. It helps to maximize your motivational gain because you subconsciously reinforce the save money and be rewarded concept in your brain.
Be sure to write down your goals and prominently display them somewhere you frequent so they’re a constant reminder of your end goal. A bathroom mirror, the fridge door, or the edge of a computer monitor all work well.
Also, consider sharing your goals with friends or family. Social media is the perfect place to share these goals. Sharing your goals with others helps to keep you fully committed to achieving them because you don’t want others to view you as someone who fails. You’ll find that if you occasionally update your friends and family about your progression towards a goal they will turn into your cheerleading team and support you along the way. This will provide you with even more motivation to reach your end goal.
For tracking purposes, be sure to record your progress on paper. Charting or graphing your progress is even more powerful than writing as you’ll be able to easily visualize your progression.
You will want to review and refine your budget every few months as you will likely be able to find new efficiencies over time.
Ready, Set, Go! Wait, Should I Cut Up My Credit Cards?
There are many people who argue that credit cards are bad and you shouldn’t own one. There are also many people who think credit cards are great because of their convenience and their added perks such as reward points, free insurance, extended warranty etc.
So do the advantages of credit cards outweigh the disadvantages?
Regularly using a credit card to make purchases is downright silly and financially irresponsible unless you pay the balance off in full every month. If you do not have 100% faith in your ability to pay off your credit card balance in full every month then you need to get rid of your credit card as it will end up costing you way more than what you will benefit from its perks and convenience.
If you fall into this category, you need to take immediate steps to prevent further spending. Even though you don’t want to officially close a credit card account until it’s paid off in full, make your card unusable. Cut it up and throw it out or place your credit card in a bucket of water and freeze it in ice so you cannot access it until you pay off and close your account.
But here’s the kicker. Even if you pay off your credit card balance in full every month your credit card could be causing you to spend more money than if you only had access to cash.
In an MIT study, researchers auctioned off desired professional basketball tickets through a secret sealed-bid auction. People were secretly given one of two auction bidding sheets. One group was told if they win they must pay for the tickets with cash within 24 hours. The second group was told if they win they must pay for the tickets by credit card and they must record their credit card details on the bidding sheet.
What the researchers found was that those required to pay with a credit card were willing to pay 2x as much for the tickets than those who were required to pay with cash. The researchers concluded a consumer’s willingness to pay is increased when they use a credit card rather than cash.
This came as somewhat of a shock to me and it caused me to analyze my recent purchases. I make all of my purchases by credit card so I can maximize my credit card reward points which I use to travel for free. I always pay off my credit card balance in full every month. The perk of traveling for free is the sole reason I make all of my purchases by credit card. It’s not for convenience because debit card purchases are just as convenient for me.
After analyzing my recent purchases, I can say with an acceptable level of confidence that my credit card does indeed cause me to spend for freely than if I had to pay with cash. I also believe this holds true, but to a lesser extent, for debit card purchases – I believe they also cause you to spend more freely than if you just had access to cash.
So, if you’re like me and pay off your credit card in full every month, you still have to consider if the perks and convenience of keeping a credit card in your pocket outweighs your increased willingness to buy things. I know it has caused me to consider leaving my credit card at home.
Now put your new knowledge to work and start paying off your credit card debt once and for all!
Have you successfully reduced debt using this system? Do you think credit cards cause you to spend more? I want to hear from you. I may even share your success story with the world.