My friend only had $5,000 in credit card debt when she asked me for help paying it off. Compared to the average person carrying credit card debt, that is far from a worst case scenario. However, this friend had an hourly job at a local drug store, far from a high income that can knock down debt thousands of dollars at a time. Like many paycheck-to-paycheck Americans, she had little savings and her income didn’t go far. Here’s how she paid off all of her debt and started saving for a better future.
Make a Budget
The first advice I had for my friend was to start tracking her income and expenses, and get all of her accounts in front of her. My favorite tool to track all of my finances in one place is Personal Capital (investing focused), which is free for anyone to use. For people starting a budget for the first time, a tool like PowerWallet might be better suited.
Once you load your info into PowerWallet, the app does some heavy lifting to import your recent transactions and account balances. It then estimates a budget for you using your monthly spending habits and typical monthly income.
Budgeting serves one main purpose. While the knowledge of how your money works is helpful for long-term planning, the real reason we budget is to control spending. The secret to growing your wealth is spending less than you earn, use any tool you can to make sure you are doing that.
Start a Debt Snowball
Now that you know where your money is going, take charge and get on track to pay off your debt. My favorite way to pay off debt, which is how I paid off my student loans, is with the debt snowball. A debt snowball is a method of paying off debt where you put a focused effort into the highest interest debt first, and then work your way through until you are debt free.
To start, make a list of all of your accounts with debt. List a name that you’ll remember, the interest rate, the minimum payment, and the balance for each account. If you do it in a spreadsheet like Excel or Google Docs, you’ll be able to sort and update as you go, but that’s not a rule. The most important part is making the list and getting started.
Each month, pay the minimum payment for all of the account other than the one with the highest interest rate. Even if the total payment is higher on some accounts, always focus on the highest interest rate first, as that is actually costing you the most per dollar.
For the account with the highest interest rate, put every dollar you can into the debt. If you can budget to free up more income each month for debt, even better. Put that into the high interest account too. Once it is paid off, “snowball” that payment into the next card, which will not be paid off much faster. Keep going until you are debt free.
Try to Increase Your Income
If you are trying to lose weight, you would be best served by dieting and exercising. Your diet is your input and your exercise is your output. You can make an effort to control both, but you’ll notice that one change can have a more dramatic impact than the other.
Running for an hour will burn about 680 calories, which is pretty awesome. But even if you run 24 hours a day, that is a total of 16,320 calories. That is the maximum you can possibly burn from running in a day.
One pint of my favorite ice cream, Half Baked from Ben and Jerry’s, has 1080 calories. You have to run for 95 minutes to burn off that pint. However, you can only burn off 15.1 pints per day if you run 24 hours straight. You can eat as much as you want. You might be better off eating no ice cream (control your input) and only running 30 minutes per day.
The same logic goes with budgeting, but the other way around. Budgeting is like exercise. You can only save so much. It is an output. Income is like eating. You have an unlimited potential to make a change there.
So work on your budgeting exercise, but don’t discount increasing your income as a way to help get you out of debt and get your finances on track. At the end of the day, you want to afford that Ben and Jerry’s, don’t you?
Questions About Paying Off Credit Card Debt?
Have you ever been in debt and fought your way out. What did you do? Are you in debt today and struggling to pay it off? Send me an email or post in the comments and I’ll help you as much as I can.
Photo by ngader / flickr