How To Pay Off Your Credit Card Debt

Nearly half of credit card holders in America report having a credit card balance. 61% of those carrying a balance reported being in debt for over one year. And of those in debt, about one in five people feel as though they will never be able to get out of debt (Source: Bankrate). All of this is to say, debt is a common and difficult situation that we find ourselves in, but it is possible to get out of it as well.

Depending on your situation, how much debt you have, how much income you make, and so many other factors, getting out of debt can be incredibly difficult. However, paying off credit card debt is always worthwhile, no matter how long or how much effort it takes.

Whether you have $500 in credit card debt, or $20,000, this guide will break down how to pay off your debt in five steps, simplifying and laying out the road ahead.

Why You Should Pay You Debt Off

As many of us didn’t grow up with the privilege to learn about personal finance, it isn’t often understood what the costs and benefits are of having different forms of debt. There are careers based off of understanding the nuances of credit cards, how to navigate the benefits, and how to best pay down accumulated debt. If you don’t have a thorough understanding of how they work, you are in the majority.

To put it simply, the golden rule of credit cards is that you should never carry a balance from one month to another. Despite a common belief, there are no benefits to carrying a balance, and will only cost you money and decrease your credit score. This means the best way to use a credit card is to always pay it in full before the payment due date.

Many people find themselves in a situation where they are unable to pay their full balance by the payment due date each month; so lets quickly look at the true cost of carrying a balance to understand why its so important make the effort to pay it off.

Looking at a hypothetical person with $10,000 of debt at an interest rate of 20%. This person will pay about $164 each month on credit card interest alone, which doesn’t include paying down any of the $10,000. ((20%/365)*30*$10,000). This is $164 less that cannot be spend on groceries, restaurants, shopping, hobbies, or anything else that is important to them. Over the course of a year, this is about $2,000 that is paid to the credit card company that they’ll never get to enjoy.

Most Americans cannot afford to pay this kind of money each year, and paying off those cards is one of the first big steps to getting your financial life on track. To determine approximately how much your credit cards are costing you each year, multiply your card’s current balance by the card’s APR (Annual Percentage Yield). If you have multiple cards, then do this for each one and add them all up.

While the math is important to know how credit cards work, you don’t need to understand it to know that your life would be better without credit card debt.

How to Pay It Off in Five Steps

Step 1: Build a budget

The first step in paying down credit card debt is finding a way to save money each month. Building a budget allows you to spend time looking at what you spend and make each month, and look for places where you can cut back on certain expenses. Before we can ever pay off any debt, we must first ensure that we are spending less than we make, which involves tracking spending, and cutting back wherever possible.

Building a budget doesn’t have to be difficult, and there are lots of great apps and programs that make it even easier. Monarch, Quicken, and Origin are a few of the most highly rated ones, and while they do cost money, their ability to help you easily track your spending, organize your budget, and simplify your finances make them worth every penny. Budgeting should be made as easy and frictionless as possible so you can build a habit of checking in and tracking it.

For many people, saving money can be difficult, so I can’t minimize the effort that may be required here. You could have a job that doesn’t pay well, bills that seem to pile up, a spending habit that can be difficult to manage, or many other factors that seem to be out of your control. All of these are totally valid, so taking the budget process one step at a time will keep you moving in the right direction. The goal is to spend less than you make each month, so look for ways that you can cut back or increase your income.

Step 2: Build up an emergency fund

Once we are spending less than we make each month, the next step is to build up a small amount of savings in our bank account. By having an emergency savings, we are able to help ourselves avoid any future use of a credit card to cover unexpected expenses. Surprise costs are inevitable for everyone, and it is important to anticipate them.

A good start for an emergency fund is $1,000, as this amount is enough to cover most surprise costs that come up frequently. This emergency fund should be set aside in a separate bank account, and should only ever be used for true emergencies, like car troubles, temporarily losing a job, and medical bills. After you pay off your credit cards, this amount should increase to cover the bigger surprises in life, but $1,000 is a great goal to start with.

If you struggle with truly setting aside money in savings and not spending it, opening a new, separate bank account without having easy access to the debit card can be a great way to make it more difficult to spend unnecessarily.

Step 3: Stop using you credit cards

While this step seems really simple and intuitive, it cannot be understated how effective and important it is to stop using your credit cards. There are a few key benefits to using your debit card to make your daily purchases, all of which will help create better money habits and allow you to get out of debt faster.

First and most importantly, not making any new purchases on a credit card will allow you to see the progress that you are making on paying down your debt. Our brains are wired to see instant rewards when we are working towards a goal. By watching the account balance only go down, we are able to see the forward progress and build momentum and enthusiasm towards the goal.

Secondly, by switching to using a debit card, we remove the temptation to shop without having any immediate financial consequences. Again, our brain is wired to seek instant gratification, and credit cards were created to fulfill our desire to buy now and pay later. This temptation can be incredibly strong, and is often what leads people into credit card debt in the first place. Removing that temptation is an important step to moving you in the right direction.

Finally, using only a debit card will hold you accountable to the budget you built in step one. Since there is only a limited amount of money in your bank account, you will have an opportunity to build a habit of keeping track of your spending and how your money flows into and out of your life. Healthy financial habits will continue to pay dividends, and while they can be difficult to form, now is a great time to start.

Step 4: Start paying down the account with the smallest balance

Now that we have some savings and we’ve stopped spending on our credit card, its time to actually pay it off. In the personal finance space, there are two very popular methods of paying down debt: the snowball method and the avalanche method. While both are great, I’ll focus on only the snowball method here.

If you have multiple credit cards, list them all out in order from the smallest balance to the largest balance. This will be the order you begin paying them off, starting with the smallest. The benefit to doing this is you will see the progress happen quickly, and you will be able to knock accounts out as fast as possible.

In order for our brain to feel the fruits of its effort, paying off the accounts with the smallest balance gives us small wins the soonest, which has a great effect on our motivation to keep going. Again, paying off credit card debt is a difficult task, and we need to focus on the most rewarding aspects so we want continue.

The amount you should pay towards your balance is determined by however much money you have from each paycheck after accounting for your other expenses. For example, if you take home $1,500 each paycheck, and you expect to spend $1,200 before your next payday, then pay off $300 towards your credit card debt immediately after getting paid.

It is important to always continue making the minimum payment on all of your cards, even if you are focusing on paying off one at a time. This ensures that you maintain a positive credit record, as one missed payment can have a severe impact on your score.

Step 5: Repeat step 4

Continue to go through and pay off each card, moving onto the one with the smallest balance next. You’ll see that some of those daunting larger accounts are much more manageable now that you have paid off the smaller ones. Again, the most important thing to remember in this process is to keep the momentum going and don’t lose track of the end goal.

After Your Cards Are Paid Off

When you get to this point, take a moment to appreciate how great it feels to be credit card debt free. This feeling of progress and freedom is what should fuel you and motivate you to continue to take care of yourself and continue working towards your goals.

Even after you have paid off your credit cards, there are a few additional questions to answer:

What about credit card points and cashback?

The business of credit cards is an interesting one, where there are seemingly free benefits that it almost sounds silly to pass on. However, these benefits will never outweigh the cost associated with paying interest on a card, meaning the only people who benefit are the ones who never carry a balance.

You have to be able to be honest with yourself, and recognize whether you have the ability and habits to be able to spend on a credit card and pay it off in full every month. One month of being unable to pay the card in full will cause the costs to outweigh the benefits, and ultimately result in having credit card debt.

In general, spending on a credit card should be avoided as the costs, risks, and habits aren’t worth the minimal benefits.

Should I close my accounts?

Once your credit cards are fully paid off, you may not see any benefit to keeping them open. However, the existence of credit scores and the way they are calculated can complicate things. Without going into details, a factor in credit scores includes the average age of open accounts. The longer you leave your accounts open, the better your score will be. This is why you may often hear that paying off debt may hurt your score, because closing down the account may decrease your average age of open accounts. This is to say, leaving the accounts open will often increase your credit score over time.

There are a still situations where it makes sense to close the card anyways, such as if the card includes an annual fee. The fees are rarely worthwhile, and the benefits are often credits for purchases that you wouldn’t have made had it not been for the credit card. Now that you are credit card debt free, you should use this as an opportunity to rid yourself of that annual fee as well. If you do have a card with an annual fee, many banks will allow you to call and downgrade to a free card, which will let you keep the credit history and not hurt your score. If this is not available, then closing the card is still the best move.

What should I save for next?

Paying off your credit cards is a huge achievement, and one you should be proud of. The basis for healthy personal finances is to set goals, and its time to look at the next ones. Here is a list of the next goals you should achieve, in order, to keep you on the right path and ensure your finances are supporting you, not holding you back.

1. Contribute to your work retirement plan up to your employer’s match
2. Increase your emergency fund to cover at least 3 months of expenses
3. Continue paying off all other debts over 6%, excluding mortgages

If you complete all of these, you are in great shape financially, and will be able to focus on some other important goals, like saving for retirement, your kids, or maybe even allowing yourself to reinvest in yourself so you can increase your earning potential.

Key Takeaway

Credit cards can often feel like a heavy weight holding you back from your goals. Unfortunately, so many of us find ourselves with credit card debt, and the nature of personal finance can make it feel taboo or difficult to talk about, leaving us to feel alone in our struggles. However, tackling credit card debt, or any other financial goal for that matter, is possible and manageable if you commit to it. Putting in the effort and spending the time is key, and certainly worthwhile. It may be difficult, but you can do it.