Cutting Your Credit Card Debt: How to Get Started

Dear Carrie: Please help. I'm determined to get out from under my credit card debt this year, but don't know how to get started. I'm currently earning $50,000 a year as an administrative assistant, but I owe $20,000 on my three cards. I'm afraid I'll never get on top of it! --A Reader

Dear Reader: Just by asking for some advice, you've taken a vital first step towards getting on top of your credit card debt -- so congratulations for taking control. I won't sugarcoat your challenge: This won't be easy, and it will almost certainly take you longer than a year. You'll need your determination and some discipline. So let's get to work.

At the risk of sounding obvious: Stop using your cards, and use cash or checks instead. Not only will this slow down the growth of your debt, it should help curb your spending in general. Most people find they spend less if they pay by cash or check. (I don't recommend getting rid of your credit cards entirely; in today's world, you need at least one or two. Just use them out of necessity, not convenience.)

Next, figure out how much you can devote to paying down your existing balances each month. Start by creating a realistic budget. You might put expenses into two broad categories: your basic fixed costs, including rent or mortgage payments, car payments, utilities and groceries, and discretionary expenses, such as eating out, travel, clothes and entertainment. If you want to get really serious about reducing your debt, you might try to change your fixed expenses (move to a cheaper living situation, for example), but probably most of your free cash will come from reducing discretionary spending.

Your budget should also include savings. I know your priority is to reduce debt -- as it should be. But make savings a part of your budget now, even while you still carry balances on your cards. Having money in the bank is invaluable for emergencies and is psychologically reassuring.

I'd set two savings goals for now: an emergency fund of three to six months' worth of expenses in case something truly horrible happens, like you can't work for a few months and some retirement investing, preferably through an automatic payroll deduction into a tax-advantaged 401(k) plan. This should be at least enough to capture an employer match.

It makes sense to pay off the highest rate cards first, obviously, so make sure you understand the terms for each of your cards. You might also see if it's possible to consolidate one or more balances onto another lower rate card. Card companies routinely offer the chance to transfer balances, sometimes with very low teaser rates, which could result in real savings in terms of your total interest expense and could also accelerate your progress in becoming debt free. (If you do a balance transfer, take note of any fees that might be imposed.)

Now you can start to pay off your card debt in earnest -- and efficiently. Say you had $600 a month for paying credit card debt. Pay the minimum payments for the two lower-rate cards and apply the rest to the highest-rate card. When that one's paid off, move to the next highest rate card. Here's a link to one of several online calculators that will tell you how many months it will take to pay down your debts: http://bit.ly/wZk1zj. I'm sure you know this, but it's so important I feel compelled to mention it: Make sure you always pay at least the minimum and never be late. Credit card companies can impose substantial fees on late payments, and you could damage your credit rating.

Getting out of credit card debt is one of the more daunting financial challenges, and some people understandably feel overwhelmed. You said you were "determined" to deal with this, and that's exactly the kind of attitude you'll need to get to the position of being debt-free. Good luck!

OK, let me see if I have this right. In your post #59 back to me, you claim that credit cards work for you as a tool and admit that it takes discipline to ensure that it does not turn into unmanageable debt. (I’ll continue to disagree with you on your stance that it is not debt if you pay it off every month.)

Then in your #60 post to Brewer you respond to his statement that he will never get into any more debt again, you reply with, “it isn’t realistic for most people.”

This is where we will have our rub. I agree that there is a very small percentage of CC users that can do so without spending more than necessary and that pay them off every month, in addition these rare birds have enough in the bank to cover their CC statement for a month or more. I also agree that you are likely one of these very few people.

That said, I can also state without a doubt that “most people” will think that they are responsible enough to use credit cards and other debt instruments, however “most people” are not. Instead it is normal for “most people” to be one small event away from crashing and burning. Heck, statistically with my having 6 months of bills in a savings account, that alone puts me in the top 10 percentile of the US population.

So, you reflect that the “proper” use of debt is just a tool, while I say that the vast majority of debt users are “tools.” Why? Well, the reality is that debt is nothing more than risk. The “tools” plan for only the positive aspects of debt and none of the potential negative consequences. Then life hits and most of the “tools” end up with the negative consequences.

You make the case that a person can become wealthy using debt tools, but that is “IF” x, y, or z.

I make the case that a person can become wealthy using cash. Period. Garunteed.

You are fine with the risk that an “IF” can bring, I prefer to not even allow for that event to be a destroyer of my wealth.

People have been using debt for time immemorial; some wisely, some not so much. But never has there been a better definition of debt than from the bible (as you well know) Proverbs 22:7 “...the borrower is slave to the lender.”

I’m not going to argue my point to justlurking because it’s pointless. I’m not trying to convince him/her to my way of thinking since it takes one of those “I’ve had it!” moments and it appears that’s not been experienced. He/she may go through their entire life using debt without negative consequence, and pass that lifestyle along to their children who may not wield the tool as well as they do. Debt will always bite. It’s just a matter of when and how.

(I’ll continue to disagree with you on your stance that it is not debt if you pay it off every month.)

If you get an bill that is payable in 30 days, is that debt? I treat credit cards like bills that are due once a month. They just consolidate other bills. Actually, if you get a plain green American Express card, it is due in full every 30 days -- they aren't revolving credits cards. You have to pay a fee for that "privilege", though... probably because they'll never collect interest from you unless your bill is past due.

Then in your #60 post to Brewer you respond to his statement that he will never get into any more debt again, you reply with, “it isn’t realistic for most people.”

Brewer is justifiably excited that he is about to pay off his mortgage. Once he has done so, it's possible to live debt-free. But, is it realistic to expect "most people" to buy a house/condo/whatever without a mortgage? Or would you prefer to pay rent while you save up the complete purchase price for a habitation? BTW, if you are paying rent, it's likely you are paying the interest on your landlord's mortgage -- he/she is just the middleman.

That's what I meant about not being realistic, but I suspect that you already knew that. Once you have bought a house and paid off the mortgage, you can live debt-free, as long as you don't travel and stay in a decent hotel or rent a car.

I make the case that a person can become wealthy using cash. Period. Garunteed.

Sorry, but a large number of people (9 million households in 2009, according to the FDIC) are already on a cash-only basis, because they don't even have a checking account. And they will stay that way, as long as they live paycheck to paycheck, spending everything that they earn.

Using only cash doesn't make you wealthy. It's a false correlation.

The only thing that makes someone wealthy (if they aren't already) is to spend less than they earn. Whether you do that with debt or without debt is immaterial. If sticking with cash induces you to spend less than you earn, then it's great that you have found something that works for you. But, it's not a panacea for all financial problems.

Guess who collects that interest. I'll bet most who read this will guess incorrectly.

The 401(k) account holder. Yes, you are paying interest to yourself.

It's one way to put more money into your 401(k) account, although it's taxable (in the year that you "paid" it).

The real disadvantage to the 401(k) loan is the lost opportunity: if the market goes up during your loan term, your money is "sitting on the sidelines". On the other hand, if it goes down, you have locked in your gain and are repurchasing shares at a lower price as you pay off the loan.

However, as someone else noted: the loan becomes due in full if you leave your job, voluntarily or involuntarily. That can be a problem.

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