Steps to Paying Off Credit Card Debt

10 Steps to Paying Off Credit Card Debt

credit card debt and investing
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The First Step Before You Can Begin Investing

One of the biggest challenges for new investors to overcome when they first decide to start building wealth and putting money away for their future is a looming mountain of credit card debt built up over several years. With balances of $10,000 or $20,000 or more, at 20% and 30% interest, they find themselves paying upwards of $500 per month in interest expense alone, never making the balance of the credit card debt decrease, adding even more frustration and pain to the cycle. This “negative amortization” as it is called – that’s when you begin paying interest on the interest you already owed because you didn’t make a high enough payment to reduce the balance – will largely be against the law due to new regulations put in place over the last few years (regulations that the credit card companies fought against, it should be noted). This is exactly why we argued that the goal for new investors should be to pay off high-interest credit card debt. These ten steps are designed to show you how to do just that.

Before you begin reading this special, it’s important to realize one key truth: Your life doesn’t have to be this way. There are tens of millions of Americans who live free from the burden of credit card debt and there is absolutely no reason you can’t be one of them. If you still feel like you need, or want, more information after finishing each step, we recommend that you check out our credit card debt family of articles and resources for even more great content that can help set you free from the burden of financial stress.

Stop the Blame Game Over Your Credit Card Debt

Do you want to know the quickest way that someone still isn’t ready to accept responsibility for their own financial life and take control over their credit card debt? It’s that they still blame others, the economy, the economic system, political system, their boss, or anyone or anything other than themselves. The only justifiable and legitimate excuse is those unfortunate individuals who find themselves in the midst of a horrible health scare and rack up massive debts to survive. Unless that’s you, there’s something you need to hear: Get. Over. It.

You are not a bad person. You are not a stupid person. You just made some foolish choices. It had nothing to do with your income. It had nothing to do with your family. Every time you swiped your credit cards, you made a willing decision to borrow what you did not have. The very first month the statement came and you couldn’t pay off the entire balance in full, you had exceeded your resources. That’s the moment you got in trouble.

This message should not be discouraging! Instead, it should empower you. If you got yourself into huge credit card debt then you have the power to get yourself out of it. It’s that simple. The moment you can look into the mirror and say, "it's my fault" and truly own the situation, you can begin to turn it around just like millions of people before you have done.

Stop Segregating Your Income Mentally

Several people close to me, mostly with whom I grew up, are in substantial credit card debt and occasionally ask my thoughts on how to get out of the situation. Although I’m happy to spend time helping them, it almost always turns out to be a pointless exercise because in 90% of the cases, the person isn’t really serious about getting out of credit card debt. Sure, they are miserable about the payments and the thing they wish for more than anything else is that their credit card statements showed a $0 balance. Wishing for something and doing something to proactively possess it are two entirely different things.

A close family member (I’ll call Jason) makes roughly $75,000 per year and has $22,000 in credit card debt. This debt is overwhelming to Jason and he spends at least a few hours every day anxious over the $500+ per month in interest payments it takes just to maintain his current balance. Yet, at least once a month, he finds $150 to go to the casino. When I ask him about it, he says that there are certain things that he won’t give up no matter how bad the debt is.

Jason might never get out of credit card debt with an attitude like that. The extra $1,800 per year that he’s spending at the casino would pay down $9,000 of principal over five years, or nearly 41% of the balance. If he could make an extra $50 per week either by working more hours or cutting costs (yes, this literally means you get on a bicycle instead of driving), he could pay off an extra $13,000 in principal over those same five years. That’s all it would take to obliterate the balance.

Instead, he thinks in terms of “my casino money” or “my grocery money”. No, you have one, giant pile of money that is available to you. If you are in credit card debt, paying massive interest on your balances, take every extra penny you can and pay down the debt.

Don't Use a Home Equity Line of Credit to Pay Off Credit Card Debt

Many financial planners will tell you to use a HELOC, or home equity line of credit, to pay down high-interest credit card debt. I’m not a big fan of this approach for one simple reason – if you do decide to use the nuclear option and declare bankruptcy, your credit card balances are unsecured, while a home equity line of credit is secured by your house.

Practically, this means that you’ve taken a debt backed only by your credit, where the worst a credit card company can do is go to court and get a judgment against you, into a debt backed by your home, where the worst is far direr – the bank can foreclose on your house and kick you to the curb.

Regardless, this is entirely your call as it’s going to come down to what will let you sleep at night. If your credit card debt is manageable, and you just want to save a few thousand dollars in interest expense, a home equity line of credit might make sense. If you think there’s even the remote possibility that you may be forced to declare bankruptcy, it can be a tragic mistake that costs you your house.

Sell Any Unrestricted Investments You Have to Pay Off Credit Card Debt

As we discussed in Should I Pay Off My Debt Or Invest?, it is almost always a better choice to lower your debt levels if the interest rate you are paying exceeds 10% to 12% and is not tax-deductible.

If you have any investments, you may want to sell them and repay your credit card balances. You want to be careful which ones you sell, though, because there can be some pretty nasty tax consequences if you make a bad choice.


Consider a 401(k) Loan to Repay Credit Card Debt

You can also consider a 401(k) loan because the interest you pay on it will go into your account (you are effectively paying interest to yourself). The bottom line is that you can avoid the income taxes and 10% early withdrawal penalty that’s piled on top as long as you repay the loan within the time frame allowed by the IRS. In most cases, you would not want to simply sell 401(k) assets, cash out, and pay down your credit card debt.


You Can Take Back Roth IRA Contributions

IRS rules allow you to withdrawal Roth IRA contributions you’ve made into your account, but not the gain earned on the money. In other words, if you’ve deposited $20,000 into a Roth IRA over the past 10 years and have made $10,000 in profit, you can withdrawal up to $20,000 without any adverse tax penalties or consequences (of course, you lose decades of growing your money outside of the reach of Uncle Sam, but that’s far better than drowning in high-interest credit card debt).


Brokerage and Other Investment Accounts

Investments you hold in regular brokerage accounts such as stocks and bonds will be subject to regular capital gains tax but the emotional release that will come as you watch a big chunk of your credit card debt should be far less painful than the cut taken by the IRS.

Pay Off the Lowest Balance Credit Card Debts First (aka the Snowball Technique)

The goal of taking control of your financial life is to increase your cash flow each month. The more excess cash you have, the more you have to reduce debts or spend on improving your lifestyle. Each debt has a minimum monthly payment. By paying off the lowest balance credit card account first, you remove an entire fixed payment, instantly making your existing money stretch further.

You then take the money you were paying on the lowest credit card debt balance and send it in to the next lowest. You repeat this process until you are left with your single, biggest debt. This practice is known as “snowballing” in the financial planning industry because the amount of money you send in to each payment gradually snowballs as each debt is reduced until you are sending in large amounts of cash to attack your biggest, and last, debt

Someone who had a $10,000 balance on a Bank of America credit card, a $3,000 department store credit card, and a $1,000 gas station credit card would send in all their extra money to the $1,000 gas station card. Once this debt was removed, they would take all of the money that had been going to it and attack the $3,000 department store card. This cycle repeats until all of the debts are repaid. It really is an effective way to reduce and pay off credit card debt and it’s easy to understand.

Make Micro Payments (aka the Snowflake Technique) to Reduce Credit Card Debt

snowflake technique paying off credit card debt
The snowflake technique is designed to help you pay off credit card debt by sending in so-called micro-payments. These payments can literally be a few dollars and, over time, add up to big balance reductions, saving you thousands in interest expense. Getty Images

You just learned about the snowball technique for reducing your credit card debt so now it's time to discuss the so-called snowflake technique. The premise is simple: Every time you get more than a few dollars in your hand, send it in to your credit card company to reduce your outstanding balance.

To make it clear: We're literally talking about $7.12 payments. Or $14.35 payments. Or $3.54 payments. If you just park it in the bank, you're going to spend it. That's human nature. If all you are able to find is an extra $2.74 per day, that's $1,000 per year taken off your credit card debt balances!

People often ignore the power of small amounts, as I wrote in Do Not Despise the Day of Small Beginnings - How Small Sums Can Yield Huge Wealth. As with everything in life, there is a compounding effect that goes to work. It's the same principal behind the Indian story of the ant that was able to move an entire mountain, one grain of sand and piece of dirt at a time. Your small efforts may not look like they're even denting your credit card debt. In the aggregate, over several years, the results will be nothing short of spectacular. It's the nature of the universe.

Cut Up Your Credit Cards (or Make Them Inaccessible)

frozen credit card debt
One technique for reducing credit card debt suggested by financial planners is to freeze your cards in blocks of ice, helping you avoid the temptation of non-essential purchases. Getty Images

Years ago, a financial planner told clients to freeze their credit cards in blocks of ice. When they were tempted to spend, they would be forced to melt the ice, giving them time to rethink impulse purchases. An even better solution is to cut up your cards entirely so that you can’t charge anything else to them. What good does it do to plug holes in your ship in you are constantly drilling new ones in the side?

“But I can’t pay my bills without a credit card! That means I don’t eat.” This may sound harsh, but I got news for you: You’re not paying your bills. The credit card is merely allowing you to postpone the day of reckoning and helping to ensure that when it does come, it will be much worse. If you're right, you will almost certainly qualify for free food assistance in your state (if you don’t, move to a state where you do – seriously). In some states, you can get up to $300 or $400 per month in tax-free food money on a debit card. If you don’t qualify, then you have a spending problem and you’re still making excuses (go back to step 1).

If you still say you can’t make due: bull crap. Again, sorry, but it’s true. When I was in my early twenties, I moved to the Midwest so I could pay $180 for my half of the monthly rent for an apartment I split with my best friend. At the time, I had a six-figure investment portfolio and virtually no debt. My goal was to build my wealth at that stage. Was it enjoyable? Not necessarily. But I wanted something very few people achieve – complete financial independence. My younger brother slept on an air mattress for two years so that he had saved more than $50,000 by the time he left the Air Force at 24 years old. If I can do it, and he can do it, then there is absolutely no reason you can do it. If you need help getting started, read How to Become Wealthy.

Get a Part Time Job or Work from Home

Another family member of mine decided she wanted to be out of debt. She determined that within one year, she was going to have paid off everything in her life, down to the brand new car she had purchased recently. She got a job as a waitress on top of her day job, saving every penny after taxes and using it to pay down the balances on her accounts. She temporarily put all investing on hold, including retirement contributions, to achieve her goal.

What she’s accomplished in short order has been breathtaking. With six months to go, it looks like she is going to easily meet her goal. By introducing more money into the equation, she was able to combine cost savings from her regular job (she got rid of her cell phone, cable, and more) to have double the effect. When this self-imposed financial diet is complete, her monthly income will go up by several thousand dollars without a single additional hour of work. In effect, she gave herself a pay raise. Despite raising her children and working two jobs, she also recently enrolled in college to go back and get her degree.

The point is a powerful one. There is nothing you cannot accomplish if you focus and are willing to accept the sacrifice necessary to achieve it. In her case, that’s going to be a year of non-stop work to give herself a fresh balance sheet and better job opportunities. Years from now, I am willing to bet that she’ll look back and realize that this twelve month period was what allowed her to go after her larger goals and dreams, which include launching her own business.

As the old saying goes, until the pain of staying the same exceeds the pain of change, you’re unlikely to move. I hope it doesn’t take that for you to become empowered and free yourself from financial bondage.

The Nuclear Option for Credit Card Debt – Bankruptcy

In the world of personal finance, the “big red button”, the nuclear option, is bankruptcy. In many cases, it is possible to completely obliterate credit card debt with a bankruptcy filing, or at the very least have a court-ordered restructuring that gives you breathing room to repay your balances and get your life in order. The opportunity cost of such a move is that your credit will be ruined for up to ten years with most of the damage removed after seven years.

For some, bankruptcy really is the best and most effective option for discharging credit card debt. It allows you to start over, almost like hitting “reset” on a video game. One drawback to consider is that the bankruptcy rules that were put in place by the credit card lobby during the Bush administration can force a lot of middle-class workers to file Chapter 13 (reorganization where you pay back the debt from future earnings) instead of Chapter 7 (liquidation where the debts are wiped out completely). Congress is currently working on laws to change this.

Smart credit card companies know this. That’s why it’s sometimes possible to get them to drastically lower your interest rate simply by explaining to them that you want to repay your debt but unless the current terms are modified, you see no alternative but to declare bankruptcy. You may have to stay on the phone for three or four hours, and keep escalating from supervisor to supervisor, but at the end of the day, you have a very, very good chance of going from 30% interest to 13%.

If you are emotionally exhausted, want to start over, and are willing to go through the process of bankruptcy, seek out a highly regarded, qualified bankruptcy attorney in your area. They can explain the drawbacks, costs, benefits, and process to you. In many cases, it’s better to just start over and begin rebuilding your life.