Payoff Your Credit Cards – But Set the Stage FIRST

It’s easier when you take care of a few things first

By Kevin M

It’s been said that the best way to accomplish a big project is to break it into a series of smaller ones. Paying off credit cards can be as big a project as we can imagine, based on the size of the debt that needs to be paid off.

Often it’s the size of the debt itself that presents the biggest obstacle to even getting started. While it may not be too difficult to payoff $10,000 in credit card debt going from a standing start, a balance of $50,000 will require marshalling all of our efforts and resources.

It’s important to realize that paying off credit cards isn’t just about discipline. A huge part of the project is emotional and you’ll have to do it in such a way that you’re rewarding your efforts by reaching crucial milestones along the way. Take it in stages, stack the deck in your favor, and the whole process will be less painful.

Implement a plan to cut living expenses

It’ll be impossible to payoff your credit card debt—or accomplish nearly any other financial goal—without developing and implementing a plan to cut your living expenses. How far you need to go to do this depends on the amount of debt that needs to be paid off.

If your debt is just a few thousand dollars, this might be accomplished by cutting at the fringes. By eliminating eating out, some forms of entertainment or cutting a service, like cable TV, you might find the necessary room in your budget to take down your debt in short order.

But if the debt is well into five figures–$20,000, $30,000, $50,000—some serious self denial will be in order. A debt of this size may require cutting not just fat out of your budget, but meat. That could even extend to modifying your living arrangement by moving to less expensive quarters or taking in an additional resident for a fee.

Alternatively, you can also concentrate on increasing your income through a second job or side business. This can be a tough balancing act, but always remind yourself that it’s a) for a good cause, and b) it’s only temporary!

However you decide to approach your plan, there won’t be any plan at all unless you can find the extra income to carry it out.

Build up a cash cushion

Once you find the proper mix of spending cuts or additional income, Step 2 is to build a cash cushion, that way you’ll have funds to fall back on in an emergency without having to tap your credit cards.

This point is fundamental. In order to get rid of your credit cards you must first eliminate your dependence on them. The only way to do this effectively and permanently is to become “self-financing”. Once you have extra cash flow in your budget and a generous savings account you will be self-financing and no longer in need of credit cards.

How large should the savings account be? Personally, I think three months living expenses is a good minimum. With a balance that size, you’ll have enough to cover reasonable emergencies and—even more important—as tangible evidence to yourself of your ability to live beneath your means. Once you reach this level you’re at least halfway home!

I favor rapid cash accumulation, and there are several ways to do this, even if you’ve never been a saver in the past. Make minimum credit card payments while you cut expenses, find extra income or even sell your stuff to raise cash. The quicker you’re able to do this, the easier it will be for you to believe that you will also be able to pay off your credit cards.

Payoff short term installment loans

There’s one more step before we start hitting the credit cards: installment loans with small balances.

Do you have a car loan with ten months to pay on it? Or a loan on a suite of furniture for a thousand or two? Get rid of them.

Here’s why:

  1. Short term installment loans have high payment-to-balance ratios, which is taxing to your cash flow. The sooner you get rid of them, the more money you’ll have to throw at your credit cards.
  2. Installment loans are typically attached to your possessions, which means that should you fall on hard times, the creditor can seize them. How sad would it be to lose an $8000 car because of a $2000 car loan that only had eight payments remaining?
  3. Debt is debt, and it all needs to go. For the above reasons, start with short term installment loans.

Even if you have lower interest rates on your installment loans than on your credit cards, pay them off anyway. This isn’t about interest rates; it’s about paying off the debts that cause the interest rates. We need to think strategically, which is to say we need to re-arrange our financial situations in ways that will bring about permanent improvement in our overall financial conditions.

Then tackle the credit cards!

With breathing room in your budget, money in the bank and the elimination of small installment loans (providing yet more breathing room in your budget) you’re finally ready to take on those annoying credit cards. And yes, I said “annoying” because with all of the above taken care of, your credit cards will be more of a nuisance than an actual problem. You’ll be attacking them from a position of strength which you have already attained and don’t need to wait to feel and enjoy until your plastic is paid. You’ve given yourself the upper hand.

Like Dave Ramsey and so many personal finance blogs advocate, I believe paying off the cards with the smallest balances first to be the most effective course. It’s the divide-and-conquer strategy where you pick off the small weak ones first. Those will be the quickest to go, and as each one does your sense of accomplishment will grow, as will the funds to take on the next card.

Once you’ve paid off the little ones, the bigger ones will seem much less daunting and you can throw everything you have at them until their gone. And you’re free.

 
Paying off credit cards isn’t just about getting rid a certain type of debt. At the core, it’s the pursuit of financial independence itself. When you owe no one, then no one owns you!

Even if we can’t be wealthy, being free from debt removes financial bondage, and frees up our time, resources and attitude to take on new careers or business ventures, to relocate if and when necessary, or just to live the lives we choose.

Have you paid off a large credit card balance? If so, what can you share about the best ways to do it?

( Photo courtesy of Andres Rueda )

14 Responses to Payoff Your Credit Cards – But Set the Stage FIRST

  1. Having the large amount of savings is the area that I found is the most flexible, myself, I favor getting a large amount of money to use to pay off the current debts, since that way if you have an “emergency”, you can shift the money from your debt pay down for it. This results in faster pay down and still allows for “emergencies”.

    As always your mileage may vary and the debt in your rear view mirror is not as large as it appears, if you really, really, want to make it go away

  2. “As always your mileage may vary and the debt in your rear view mirror is not as large as it appears, if you really, really, want to make it go away.”

    HOW TRUE VITAEUS! Different strokes for different folks.

    You’ve hit on a point I tried to make in the post, but you did it better, the comfort and options you have by having a savings cushion. That gives a solid platform to launch the assault on your debt.

  3. Kevin,
    The key is your first step: implement a plan to cut living expenses. To think that one can make progress otherwise is naive and probably a form of denial. But the sacrifice is putting words into action…and that sacrifice is the emotional impetus that is absolutely necessary. You were right on in saying that this is more than discipline: it is an emotional issue. Hating debt is a great start!

    Good post…should help lots of readers!

  4. Thanks Joe. So right, it comes down to the basics, like cutting expenses. If you can’t do that, the rest is just wishful thinking!

  5. Recently, I incurred a $6,000 bill that I needed to pay quickly. Unfortunately at the time my only choice was to take out a cash advance on my credit card, at 24 percent!!

    Having a good credit rating, and equity in my home (that was purchased 25 years ago..) I was able to obtain a second mortgage / line of credit on my home a 3.75 percent.

    Now I have no credit card debt, and I plan on keeping it that way! In the mean time, I am putting at least $300 a month towards paying off the second mortgage. More when I can afford it! And all the while building up my emergency cash fund so as to ease the future surprises.

    Thanks for the post!

  6. Mike, be careful with that home equity line, in reality it’s a credit card secured by your house. The 3.75% rate is excellent, but it can also be a snare, enticing you to borrow because it seems so cheap.

    You’re on the right path with building emergency savings and carrying no credit cards!

  7. I know I want to get off of credit cards. I’m not there yet… if I can save up enough money so when the car breaks I don’t need credit cards, then I’d be fine. That is where I am trying to get to. My credit card was $0 until the transmission needed an overhaul… $2700… then the big plumbing repair 5 months later to the tune of $522.

  8. Yeah, we have to shift the “cushion” from credit cards to savings; until that happens it’s too easy to be locked into the debt cycle. I really think that’s how most people get into credit card debt, much more so than extravagent spending.

  9. Great post, Kevin!
    It’s so important to eliminate bad debt, and I find that so many people are so ambivalent towards it. They just think that it’s a part of life and everyone lives that way. It’s sad, to be honest.

    Keep up the great work!

    Jon DeGroff

  10. Great article.

    It’s key to control that credit card debt. Credit is not the same as money; guessing that’s where people get the most hung up.

    Consider using the snowball approach to repaying debt – paying off those small debts with huge interest rates first, and then rolling the money into the other payments until it’s all paid off.

  11. Jeff – Very good point, credit is not the same as money. Credit has been so streamlined in recent decades that it’s really hard to tell the difference, and it is significant. No doubt that’s both how and why so many people got so deep in debt.

  12. Many people come end of the year they find that they need this and that item. They forget to note that credit card is debt and you will pay it off with a price. Discipline yourself and don’t over spend if you dont know how you will emerge from the situation.

  13. Mary – That’s why I prefer using cash or a debit card. There’s no expense carryforward into the next month when you leave the credit cards home at shopping time.

  14. @Kevin: I agree with you man, it is still the best to use your debit card rather than using your credit card, no interest to pay and the best of it was no headache will arise if you over purchase on your credit cards. Though this article is great, that teaches us how to use our credit card wisely so we can set plans on paying them on time.

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