“You want 21% risk free? Pay off your credit cards.”- Andrew Tobias
Did you know, I hate paying for other people to use and manage my money? I hate bank fees, I hate late fees, I hate paying compound interest on my debt.
The all time worst deal on taking out a loan (that is what a credit card is, kids) is the interest rate you pay on credit cards. One of my cards is 17% interest! That means if I have $1000 worth of debt and I only pay off the minimum ($25 a month, on that card) it will take me FIVE YEARS to pay that debt off and it will cost me $1486! I end up paying almost 50% more for everything I bought with my credit card- not savvy at all. You’re paying for designer and you’re wearing TJ Maxx (that you bought five years ago). Don’t do that!
Not only is not paying off your credit cards immediately bad for your closet and your wallet, but you should think about where you want your money to go, as a consumer. You have to buy clothes and food, and you have the option to spend your money on other things. You can buy yourself more shoes, donate to charity, buy organic food, buy video games, save for Lasik, give your money to your sister, pay your college loans off, buy some new wallpaper. That’s awesome- you get to choose where your money goes, and you can invest in yourself, others, or in something you believe in.
If you are spending your money on credit card debt, you are spending your money on supporting credit card companies. Companies that exploit the part of human nature that loves immediate gratification. Yuck. That is not where I would choose to put my money. I’d rather have a new pair of shoes.
Stop a minute. How are you feeling? If you have any credit card debt, you probably feel guilty and annoyed that I am telling you how horrible something that you already hate is. Completely valid feelings. The real way that the economy works is that it takes advantage of a few flaws in human nature, and it rewards people who can thwart those instincts with their massive brainpower (I’m talking to you, my brilliant reader!)
The reason why credit card debt is so common is because of something called future discounting (sounds fancy, and it sure is! You’re going to learn something new today). Future discounting is human nature. It means that you place less value on $110 that you will get in the future than $100 in your pocket today. You can spend that $100 today, but what is that $110 in the future gonna get you? You will probably have way more money in the future, and maybe that $110 will not buy as much because of inflation, so you would rather have $100 right now. This is how credit cards work. Foiled by our own future discounting!
How do you overcome this teeny flaw in human nature to become the master of your own destiny? Here is the strategy:
1. Stop charging more than you can afford. Look at your budget. Is what you are charging in the budget? Will you have enough in your checking account to cover this purchase? No? Then don’t buy it. Check out my tips to slenderize your spending.
2. Pay off more than the minimum amount due and set up automatic bill pay so you don’t tempt yourself to just pay the minimum when you pay your bills. If I made $50 payments instead of $25 payments on my TJ Maxx debt, I would pay off my debt in two years and it would only cost me $1184 total- you can save $302 just by paying a little more off each month! Stopping compound debt in its tracks feels just as good as earning compound interest.
3. Think about interest rates. If you are investing $50 a month and earning 6% and you are paying off debt that is costing you 17%, you should be putting that $50 investment money towards your debt. You will save more money on paying off debt interest than you would make investing. If you have any wiggle room in your budget and if you are putting money into long term savings, I recommend that you shift that money over to debt reduction (provided the interest rate on your debt is higher than the interest rate on your savings).
If you have more than one credit card, pay off the card with the highest interest rate first. Some schools of thought say that you should pay off the smallest amount first so you have a victory under your belt and you stay motivated- that is fine too, but it will cost you more (but spending money to stay motivated is a legitimate expense so if it works for you, go for it!)
4. If you haven’t maxed out your credit cards and you still have access to some funds in a pinch, it is better to wait before building an emergency fund. If an emergency does happen before you have an emergency fund, you will probably put the expense on your credit card where you will be charged interest- but only if an emergency happens. If you build an emergency fund while paying off your debt, you will definitely pay that interest on your debt. Go with the option where you MIGHT pay interest rather than the option where you WILL pay interest.
5. Call your credit card companies. See if they can lower your interest rates, and while you’re at it, see if they can stop charging you any stinkin’ fees you might be paying. They work for you, and if they won’t help you can always tell them you are thinking about closing their credit card- they hate losing customers.
6. If you are still drowning, think about consolidating your credit card debt. To do this, you can transfer your debt over to a card with zero interest for a certain amount of time. There are a few pitfalls, because opening more credit cards is not necessarily good for your credit. If you choose to do this look for the lowest interest rate. That being said, don’t charge more just because you have an amazing (or no!) interest rate for a certain period of time. It will bite you in the butt and then you will have to start over at step 1.
7. Make a plan and stick to it! If you have promised yourself to pay off your newly consolidated debts, that should be your main financial goal. If you are having a hard time laying off the plastic, switch to a cash-only budget. I just read a study that found that spending is reduced by 20% on average when you use cash instead of credit cards.
You might be finding this completely intimidating. You might feel like it is hopeless and you will be mired in debt forever. YOU WILL BE FINE. Just like saving up for Lasik, eliminating your debt is a slow process. Cut back on your spending, automate your bill payments, and relax about it for now. You have a plan, you are following the plan- and you are right on track. So pay attention to your debt, but stop worrying about it. Check back in in 3-4 months. See how your progress is. Readjust if you need to. When you make a plan for yourself and you follow that plan, you are making the best financial decision that you can make. Instead of worrying about unknown debt you can now say with confidence that you are in control of your finances and there is no need to worry about the unknown. Do you feel better? Me too.
Hi Kate! This blog is really great! During my Fellowship and afterwards, I learned a lot about personal finance, made a concrete budget for the first time and paid off the credit card debt that I had stupidly accumulated as a poor grad student. Now I’m tackling my student loans and strategizing on a plan to pay them off faster. I can definitely relate to many of the issues you discuss. I used to be intimidated by personal finance too and just didn’t want to deal with it but now I feel empowered and in control. Budgeting isn’t ‘sexy’ but its such an important skill and reaching personal financial goals (even if they’re small) provides a nerdy sense of achievement. Budget on!
Thanks, Krissy! I have really been enjoying writing the blog and it makes me so happy to hear that it is helping people tackle the tricky parts of personal finance!