Updated: Feb 3
As someone who has dug myself out of credit card debt a couple times, discussing the best way to get out of debt isn’t just some academic exercise. It’s sharing what worked for me, considering the fact that nobody’s perfect, myself definitely included.
In addition, in the process of working with people who are struggling with credit card debt, I’ve also noticed some common mistakes they make that if avoided, could really accelerate the arrival of their Debt-Free Day. Here are five ways people mess up their debt pay-off plans:
Mistake #1: Neglecting to address the root cause of the debt first.
While a lot of personal finance folks assume that credit card debt is the result of irresponsible behavior, I observe differently. Plus, I see NO benefit in shaming people for past behavior, since I’ve been there in that place of racking up debt, knowing it, and not knowing how to stop it at the time (or knowing, but not being willing to).
Most credit card debt stories start one of three ways:
A job loss that doesn’t lead to any spending cuts.
An accumulation of unexpected expenses like vet bills, travel for family emergencies, car repairs, etc. that snowball into a feeling of “whatever” as you keep spending.
Reimbursable work expenses that come in after the bill is due and aren’t applied against the balance.
Before you can really implement a debt reduction plan, you have to first address the reason you got into debt in the first place. This is typically a lack of a slush fund for unplanned expenses compounded by living beyond one’s means or living too close to the edge with paycheck-to-paycheck spending.
Build up a small slush fund
First, you have to find a way to make sure that you’re spending less than you make each pay period, while also setting aside an amount each month to build up that slush fund. The way I did this was by making savings automatic — I started with $25 per paycheck to a separate savings account that I didn’t see every time I logged into my checking.
Review expenses for even small cuts
I also found a few expenses to cut, such as switching my cell phone plan to one that was $20 cheaper per month, then adding that $20 to my automatic savings plan. Eventually I worked my way up to putting $350 per pay into savings through adding in little things like a pay raise, or an account paid off, etc. In other words, when an expense went away, rather than absorb it into my spending, I added it to my savings.
Build your "back-up" fund
This allowed me to start a back-up fund that, for a few years, I had to “borrow” from to plug gaps when things came up, but eventually I was able to let the account build up. Essentially this kept me from having to add to my debt while I was paying it down. After several years this fund became my “walking away” fund that allowed me to quit my job in the middle of a pandemic and not worry about finding a new source of full-time income right away.
Mistake #2: Continuing to use cards while paying them off.
I have seen so many people try this, thinking they would just pay off the new charges each month plus an added amount toward the old balance. It’s often driven by a desire to earn credit card rewards like airline miles or cash back. I don’t care what kind of record keeping system you try, this never works, and the resulting extra interest far exceeds any rewards you earn. I’ve tried, I’ve had clients try it, and it always fails.
You have to stop using credit cards in order to pay them off.
No way around it.
Once you’re debt-free and have a robust slush fund, then you can shift back to using cards for rewards, but while you’re carrying a balance, just put it away.
Mistake #3: Using low interest promo offers to pay off old cards, then running up the new card.
When done correctly, using cards with promo balance transfer offers can be a great way to expedite a debt pay-off plan. Where it goes completely off track is when people either continue to use the card that was paid off or when they use the new card for purchases, thinking they might as well take advantage of the low promo rate. (See point number 2. If you really want to get out of debt, you have to stop using debt in order to get there.)
Mistake #4: Worrying too much about their credit score.
There are multiple factors that affect your credit score, but carrying a balance on your credit card is not required to boost your score. It’s the ratio of your balance to limit and the timeliness of your payments that matters.
Besides, your credit score really only matters when you’re trying to borrow money and sometimes when applying for a new job.
When working on a debt pay-off plan, the primary number you should be focused on is the total balance of your debt (and making it go down), which will naturally improve your credit score.
Mistake #5: Making payments willy nilly.
When little windfalls occur such as tax refunds, work bonuses or even income from a side gig, it’s a great idea to direct that money toward paying down debt. But I often see people just randomly throwing this extra money at balances without looking at the overall picture.
When you find yourself with unexpected extra cash, first make sure that you have a little safety net in place to help in times of unexpected extra expenses.
Once you have the safety net in place, then consider putting some of that extra money toward the account with the highest interest rate, and simply add it to your monthly payment rather than just a random mid-statement payment.
It comes down to this
Above all, the most successful debt pay-off plans start with an actual plan. Figure out how much you can afford to pay each month toward the debt, then treat that lump sum amount like a fixed bill until all the debt is gone. Once you’ve paid it all off, you’ll already have a nice amount that you can direct toward saving for other goals. That’s how I did it!
Kelley C. Long, CPA/PFS, CFP® is a virtual financial coach who specializes in helping people address the root causes of their financial challenges and anxieties. Visit Working with Me to learn more.