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Case Study: Getting Out of Credit Card Debt Effectively

by Matt Jones, CPA
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Most articles on credit card debt tell you to “spend less”, which, frankly, is terrible advice; it’s the equivalent of a coach saying run faster or a dietician saying eat less.

I’m going to share the two keys of getting out to credit card debt effectively – paying cash and setting credit card payment goals – and Nicole’s story of getting out of credit card debt.

Step One: Pay Cash

This is going to sting a bit. The first big step is paying cash for all purchases going forward. Ideally, you’ll leave your credit cards at home, but understandably, you might like having one with you for a safety net. If you carry your credit cards, commit yourself to not using them for anything except an emergency.

Why pay cash? Because according to this MIT study, you spend almost twice as much when using credit cards vs. cash. Scientists believe the delay in paying your credit card balance (and the option to make just a partial payment) reduces the “pain” of making the purchase.

Step Two: Set Credit Card Payment Goals

Look at your credit card balance today and set a realistic timeline to pay it off. Write down your goal for the balance each month and then do your best to achieve it. You might not hit the budgeted balance number every month. Don’t beat yourself up! But, your remaining balance should at least be lower than it was the month before.

The amount you pay each month should be more than the minimum required payment. This can be tough at first, but it will get easier as you pay off more of the debt. Paying just the minimum, you could end up spending more on interest payments. How much more? More than the amount of credit card debt you began with!

What does this look like in practice? Here’s a recent story of putting this into practice. For simplicity I’ve rounded the numbers and for their privacy, I’ve changed the person’s name.

Case Study

A graduate of Cleveland State University reached out to me for advice on paying off her credit card debt. We’ll call her Nicole. Nicole works in finance and has been out of school for three years. She makes the minimum payment on her student loans each month.

At the end of 2019, Nicole has just over $6,000 in credit card debt on two cards,1 and asked for advice on how to tackle the balance (and relieve the stress of carrying the credit card debt). 2

In addition to her student loans and credit card balance, Nicole has a car loan with a balance of $11,107 and two 401k accounts (one from her prior job and one at her current job) with nearly $8,000 in them. Lastly, Nicole has $4,000 total in her checking and savings accounts.

The first step Nicole and I took together was an inventory of her accounts, adding the positives and subtracting the negatives, to get her Net Worth at 12/31/2019. To begin tracking your own Net Worth, download my free tracking tool.

Here’s a valuable tip: if you pay off your credit card every month, you get charged ZERO interest. Said another way, you only get charged interest if you don’t pay off your whole balance each month. This is our goal.

Click to zoom – Nicole’s Net Worth

Nicole did a smart thing. I advised her (and she listened!) to transfer her credit card balance from her Chase card with a 19% interest rate to her Student Credit Union card which only charges 9%, effectively cutting her interest in half.

Over the course of a year this should reduce Nicole’s interest expense by several hundred dollars. You’ll notice this comes before step one listed above. If you have multiple credit cards, look at the interest rates they charge and consider a balance transfer. Check to see that they don’t charge a fee to transfer your balance- it’s worth calling them to confirm this fact.

Next, Nicole agreed to begin paying cash for all of her expenses. In fact, she didn’t even carry her credit card with her. As mentioned earlier, this caused her to think twice about how much things cost and prevented impulsive buys.

You probably noticed that Nicole’s Net Worth is negative – it’s not unusual, mine was when I graduated. Don’t be embarrassed. The key is to work toward increasing it.

Now that Nicole and I created her Net Worth tracker and she transferred her debt to her Student Credit Union card, we came up with a plan to pay off her credit card debt. The 9% interest rate on Nicole’s Student Union Card is very high compared to other debt, including her student loans at 6%. Even though the credit card balance is less than her student loans, the 9% interest rate means that Nicole will prioritize paying off her credit card.

Nicole’s Payoff Plan

Nicole and I noticed that she typically increases her Net Worth by about $500 per month. That money will now be going to her credit card payment. Easier said than done, right? Yes, this is a tough challenge. I’ve gone through it myself, almost all of us do. Set up your monthly goal, do your best to achieve it. Some months you will, but others you’ll miss it.

In the past, Nicole had prioritized paying off her student loans, having cash on hand, and investing rather than paying off her credit cards. As bad as having the credit card debt felt, she enjoyed improving the other accounts much more – and thought that decision was the “right” one.

Click to zoom – Nicole’s planned credit card payments

Nicole and I decided that while paying down her credit card she should should continue to contribute to her 401k and make the monthly payments on her student loans and car payment, but your situation may vary. Always make your minimum monthly payments since late fees can add up quickly and derail your progress. I recommend Ramit Sethi’s excellent book I Will Teach You to Be Rich for automating all your payments and eliminating fees. 3

I’m happy to say (and really proud) that Nicole followed her plan closely and paid her credit card balance to below $500 at the end of the year. Now Nicole pays off her credit card in full each month. She has much less stress, and can focus on paying off her student loans and contributing to her retirement accounts.

In the months since, because Nicole is not paying $500 toward last year’s purchases made on her credit card, she uses that money any way she chooses. She doesn’t feel guilty about spending the cash and is proud of her achievement.

Getting Started

It’s not unusual to have psychological preferences that push each of us to deal with money in a way that isn’t the best financially. That said, when you want to eliminate credit card debt, do your best to keep emotions out of it.

Note: I’ve always manually tracked my net worth on a spreadsheet – Here’s my free template. The logic here goes back to spending cash versus using a credit card. Apps, while convenient, can lead right back to “Oh well, I guess that’s what I spent this month”.

By tracking your finances manually, you will better learn how each action impacts your overall Net Worth.

There are apps out there which help track your finances and spending. In the past I’ve used Mint.com and PersonalCapital.com. Both have their strengths. I find them most useful in pulling together my financial information necessary for my Net Worth spreadsheet each month.

Good luck on your credit journey! Feel free to share your stories in an email to me or in the comments below.

Thanks,

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