Credit cards work like magic. All you need is to swipe that card, and your wish is granted. There is nothing to dislike about this wonderful piece of plastic – unless you have amassed credit card debt.
Our love for plastic money is clear – credit card loans surpassed $1 trillion in 2019. And the average American household also carries a revolving credit card balance of about $6,849, which amounts to approximately $1,162 in annual interest.
If you’re guilty of overusing your credit card, now’s the time to act, even if the amount you owe seems intimidating. By creating a plan, starting slow, and staying consistent, it’s possible to put a sizable dent in the balance.
Step #1 To Reduce Credit Card Debt : Know How Much We Owe
The first step to attacking our debt is to face it head on by creating a list of every single debt owed. The list should include to whom the debt is owed, the outstanding balance, the interest rate, and the minimum monthly payment. Once complete, it provides a starting point for the attack.
Step #2 To Reduce Credit Card Debt: Calculate How Much We Can Afford to Pay
Based on our income and expenses, calculate one maximum dollar amount that we can afford to pay towards our debt each month. Ideally, it’s greater than the sum of all payments on the list we created.
Step #3 To Reduce Credit Card Debt: Attack Our Debt
Depending on our preference, there are two popular strategies for attacking our debt:
#1 Snowball Method: Repay the credit card with the smallest balance first, paying as much as we can on that one and leaving just enough to cover the minimum payments on the rest. Seeing debts disappear from our list is a real motivator. Once the smallest-balance debt is paid off, we move to the next smallest, until they are all gone. Let’s assume that we’ve calculated $750 as our maximum monthly payment amount and that our list includes three debts as follows:
Using the Snowball method, the minimum payment is made on debts 2 and 3, which totals $500. The remaining $250 goes towards attacking debt 1 because it has the smallest balance. Once the balance reaches $0, the minimum payment would be made on debt 3 and all excess funds would go towards attacking debt 2 because it has the next smallest balance and so on.
#2 Avalanche Method: Repay credit card with the highest interest rate first. We pay as much as we can on that debt, leaving just enough to cover the minimum payments on the remaining debts. Once the highest-interest debt is paid off, we move to the next highest-interest one. This method may not have the motivation factor of the Snowball Method, but it makes the most financial sense as we are getting rid of the debt that costs us the most first. Let’s assume again that we’ve calculated $750 as our maximum monthly payment amount and that our list includes the same three debts:
With the Avalanche method, the minimum payment is made on debts 1 and 2 and all excess funds are used to attack debt 3 because it has the highest interest rate. Once debt 3 is paid, we’d move to debt 2 because it has the next highest interest rate and so on.
Attacking – and paying off – debt has a dual benefit. It reduces our interest expense and frees up money that be put towards achieving our financial goals.
Step #4 To Reduce Credit Card Debt: Refinance Our Remaining Debt if Possible
Regardless of whether we attack our debt with the snowball or avalanche method, once we get into the habit of slowly (or quickly) paying off our debt on a monthly basis, we should consider refinancing our outstanding credit card balances if doing so will lower our overall interest payments. Two refinancing options are possible:
- Balance Transfer: We can transfer our credit card balances to a 0% or low-interest card that reduces our interest payments for a specific number of months (usually 12-18 months, also known as the promotional period), as long as we meet our minimum monthly payments.
A balance transfer will generally cost us between 3% and 5% of the credit card debt transferred. For example, if we transfer $10,000 to our new card, the issuer will charge us between $300 – $500 in transfer costs. We also need to be certain that we are on time with every payment; otherwise, we may incur significant fees.
To be successful, we will also need to carefully monitor and adjust our plan in attacking and paying down the debt that is transferred because once the promotional period ends, our interest payments will skyrocket.
- Personal Loan: We can take out a person loan to clear our debt. In recent years, the market for unsecured personal loans has exploded with Fintechs like LendingClub, Prosper, SoFi and Avant leading the way. For an unsecured loan, you do not have to put down any collateral, such as a home or a car, which means the lender cannot automatically take possession of your property if you miss your payments (they can sue you though). With a secured loan, the lender can take away your car, home or whatever collateral you have agreed, if we miss our monthly payments.
A personal loan can cost us between 1% and 6% of the loan value, so if borrowed $10,000 to pay off our credit card, that $10,000 would cost us $100 to $600 in fees. We should also remember that we have to make fixed monthly payments to pay off our personal loan and that prepayment penalties may apply if we decide to pay it off early.
Being able to get a good balance transfer offer or a personal loan with a lower interest than what our credit cards currently charge us depends on our credit score. And even though our interest expense will be lower after we refinance – which means our minimum monthly payment will also be lower – we should still pay the maximum dollar amount that we can afford to pay towards our debt each month so that we can become credit-card-debt-free as soon as possible and move towards achieving our peak financial form.
Step #5 To Reduce Credit Card Debt: Review & Revise Our Plan
There are many moving parts to our five-step credit card debt reduction plan and even more moving parts on our overall financial fitness journey, such as cutting overall expenses, increasing income and setting up a budget (just to name a few!). Perhaps after a few months of paying off our debt, we find ourselves able to pay off a larger amount each month or perhaps, we’ve paid off everything and need to decide what to do with all of our savings! As a result, we need to regularly review and adjust our strategy to make sure that it still fits with our current situation.
When There’s No Other Option
Debt settlement and declaring personal bankruptcy should only be considered as absolute last options – they come with massive drawbacks. Both will destroy your credit score and chances of borrowing for many years. They also take a long time to finalize – sometimes years – during which time your debt will keep growing and your overall financial situation will continue to worsen.
We all get saddled with credit card debt for different reasons. But if we managed to get ourselves into this situation with certain spending behaviors, then we can certainly get ourselves out of this situation by changing these spending behaviors. Discipline, focus, restraint and a complete overhaul of our spending habits are necessary ingredients for success – difficult as it might be and long as it might take. That is where I, and our team of expert financial coaches, come into the picture – to figure out with you, what works best for you. A whopping 88% of respondents from Price Waterhouse Coopers’ 2019 Employee Wellness Survey felt that having some form of help or guidance with managing their personal finances would improve their overall financial picture.
Research also shows that when we have a coach who encourages us, with whom we can speak to openly and honestly, the chances of achieving our goal skyrockets to 95%. Let’s go back to the gym again and think about that personal trainer, who pushes us every time to do those last ten reps and get in better shape. That is what we do at Diamond NestEgg – we’re here to guide you towards your peak financial form, to support you when things are great and, even more importantly, to help you push through when they’re not so great – because all of us fall down sometimes and need a little help picking up the pieces and getting back up.
So Let’s Start Improving Your Financial Fitness Together
Whether you’re just hopping onto the financial fitness train or you’re already well on your way and want to tweak a few things, or even if you don’t know what do next, shoot us an email at email@example.com or call us on (212) 729-4841 for a quick chat.
We’re on a mission to improve the financial health of hard-working Americans, to stop the money worries at home and at work, and to give you back control of your finances, so let’s do this together and get into tip-top financial shape. No matter where you are now financially or where you want to get to, we’re here to listen and support you every step of the way.