Credit Card Payoff Strategy

by Gary Foreman


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Dear Dollar Stretcher,
Due to a divorce a few years ago I was the one that ended up with all the credit card debt. I can't seem to get out from under. I have tried the CCCS. But because I am not terribly delinquent, I have been paying the "minimum" due on the cards most months, I did not qualify. I need some help consolidating this debt. I haven't used the cards except for emergency purposes (car maintenance), but they don't seem to be paying down. The interest rates are too high. The minimum payments don't seem to be much more than the interest. I will pay off my car in 10 months. That will free up about $300 a month, but until then, I feel like I'm throwing my money away. Suggestions are desperately needed.
Denise E.

That a good question! It's also a common problem. Recent studies show that only about one third of all credit card users pay their bills completely each month. In fact, Americans owe $2.5 trillion in consumer debt. So Denise has lots of company! But with an organized approach and some determination you can get out of debt.

Denise is already taking the first step. She's not adding any new credit card debt. And that's important. When you want to get out of a hole you quit digging! If you continue to use your credit cards no plan will eliminate the debt. No credit counselor, debt consolidation loan or anything else will work. The only thing that's going to help is to take a good, hard look at yourself and decide if you're willing to make some lifestyle changes to solve the problem.

Next, let's get a feel of where we stand today. Make a list. You'll need to include all your credit card debts. List the amount of the debt, the interest rate charged, how much interest is charged each month and what your minimum monthly payment is. You may need to calculate the interest rate by dividing the interest charged by the total amount owed. Total all the columns (except "interest rate").

Start with the totals. Compare the total monthly minimum to the total interest charged. You'll find that they're pretty close. So if you're just paying the minimum each month you'll be in debt for the rest of your life.

You've just uncovered the card company's biggest secret. When you're out shopping the only question they want you to ask is 'can I afford the minimum' each month. But if you do that you'll be wasting the maximum amount of your income on interest payments.

So how do we break the cycle? We must recognize that we're fighting two battles. The first is a battle for your mind. You want the freedom of being debt free. They want you to believe that it's not possible and that no one else is debt free either.

The second battle is to maximize the amount of your monthly payments that goes to paying off the principal owed. Please notice that I didn't say that you need to pay more each month. Of course if you do pay more your debts will come down. But can we accomplish the same thing without writing bigger checks?

Take another look at your list. What's the highest rate of interest on the list? Chances are it's over 14%. That's the debt that we're going to attack first. It's the one that's inflating the "interest charged" total. Let's do a 'what if'. Take the highest interest debt and divide the interest charged by two. Total your columns again. What happened? The difference between what you've been paying and the interest charged just went up. That means that you applied more money to paying off your debt. We've just illustrated the strategy we'll be using.

There are a number of different ways that we can reduce that highest cost debt. We're going to pay it first. Where will we get the money? Here's a couple of places to go. If you've been paying more than the minimum on any accounts, change your strategy to just pay the minimum. Then apply the extra to your high cost target account.

As you pay down your debt you'll have additional money available to you. Add that extra to what you've already been paying on the highest interest debt. As you begin to reduce the interest charged you'll find that the process snowballs in your favor. First you eliminate a 21% account. Then that money is applied to an 18% account. It gets easier as you go.

Suppose you're really in a bind and can only afford the minimum on each account. What then? There's still two things you can do reduce the highest cost debt. The first is to call the credit card company and ask for a lower rate. Stress that you've paid on time. Or that you've been a long term customer. Even if you can't think of any reason, try anyway. You have nothing to lose but the phone call. It's surprising how often a rate will be lowered if you ask.

The second method is to transfer the debt to a lower cost card. Perhaps it's to a card that you already carry. Or you might need to take a look at the offers that flood your mailbox. Look for one that has a low introductory rate. Even if it's only for six months or a year, you've lowered your interest charges and found some money to pay off principal.

One caution. Many cards charge you to transfer a balance to them. Some treat it like a cash advance. Make sure you know what charges, if any, will be applied before you make a transfer.

Here's the payoff. You're going to keep paying the same amount towards all the accounts combined as you did before. If you've been writing checks that total $400, make sure that all your payment still total $400. But, any money over the minimum amount due on each account will go to the highest interest account until it's paid off.

Does the strategy work? Try it for three months and then make a new list. Then compare the two lists. You should see that the total amount of interest charged and the total amount of debt coming down.

That's important. Remember the mental battle we talked about earlier? You need encouragement to reach your goal. One way is by comparing your lists and seeing what you've accomplished. Another way is when you find that you're writing fewer checks to pay bills each month. It's a good feeling when an account 'bites the dust'. In fact, some advisers suggest that you take a smaller account and pay it off first. In any case, when you get discouraged compare your current list to the one at the beginning. Then pat yourself on the back!

A final thought. Denise said that she felt like she was "throwing money away". And she's right. The money you spend on interest charges doesn't buy you any more food, housing or goodies. Ask yourself a question. Suppose you had the money you spend on interest payments each month because you were debt free. If you used that money for you and your family, how much better would your life be?


Gary Foreman

Gary Foreman is a former financial planner and purchasing manager who founded The Dollar Stretcher.com website and newsletters in 1996. He's been featured in MSN Money, Yahoo Finance, Fox Business, The Nightly Business Report, US News Money and he's a regular contributor to CreditCards.com. You can follow Gary on Twitter or visit Gary Foreman on Google+. Gary is also available for audio, video or print interviews. For more info see his media page.

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