You may have heard that the pandemic gave many Americans the opportunity to save more and pay down debt. While that may be true for many, it wasn’t the case for everyone. According to a September 2021 Bankrate survey, more than half of U.S. adults (54%) carry a balance on their credit cards, and 42% of consumers with credit card debt have added to the amount they owe since the pandemic began.
According to NerdWallet’s 2021 American Household Credit Card Debt Study, the average revolving credit card debt owed by an American household with credit card debt is $6,006. So let’s take an average family (we’ll call them the Smiths) and figure out what it would take to eliminate that debt. Assuming this household has one credit card (with an interest rate of 16%), makes a minimum payment of about $141 per month, and doesn’t charge another penny on their card, paying this off would take 64 months — over five years! — and cost $8,933.77 (including accrued interest). But what if the Smiths wanted to pay off this debt in a year? Here are some steps that could help them — and you — achieve this goal:
Track Your Spending: Before you think about paying off your debt you need to make sure you don’t need to add any more money to the balance you’re carrying over each month. The best way to do this is by creating a plan for your spending. Start by writing out your income and expenses, tracking things in an Excel spreadsheet, or (my favorite) using an app. Take into account how these might vary from month to month. My simple budgeting method can help. Be sure to use your real (not your ideal) spending patterns by taking a look back at your bank and credit card statements. No judgment, just get to know your habits.
The Smiths’ Step: To get a better handle on where their money is going, they decided to use an app called Mint to track their expenses and income from all of their accounts.
Create a Manageable Spending Plan: Most people assume that in order to pay off debt they need to give up everything they love, which couldn’t be further from the truth. In fact, making brash cuts in spending is one of the best ways to get yourself back into debt again because you might be prone to “revenge spending” after all those cuts! Instead, consider what you really value spending money on. For my husband and me, that's food and travel. We’d happily cut our budget in just about any other area as long as we could keep those. After you choose the expenses that really matter to you, take a look at the rest: Are there any you could reduce or eliminate? The goal is to not only make ends meet but potentially give yourself a little extra income to pay off debt.
The Smiths’ Step: The Smiths decide to prioritize dining out once a week and going on a family outing together once a month. To ensure they are able to make ends meet each month, they are reducing their subscriptions/memberships (saving $50/month) and eating at home for each meal outside of date night (saving $100/month). This isn’t money the Smiths are putting toward their debt. This $150/month is helping them make sure their income and expenses match so they don’t have to take out additional debt. In order to generate additional income to put toward debt, they are trading their yearly cross-country family vacation for a road trip to a cabin just a few hours away (saving $1,300 total), and to limit any personal shopping to just necessities until the debt is paid off (saving $100/month). This $1,300 and $100/month is ready to go towards paying down their credit card debt.
Bring In Additional Income: A few ideas: starting a side hustle (or bringing in additional side hustle work), asking for a raise, tapping into tax refunds or bonuses, or selling household items. Every little bit helps to chip away at the debt!
The Smiths’ Step: The Smiths agree to use their expected tax refund, $2,827 (the average tax refund for 2020), and Mrs. Smith plans to ask her employer for a much overdue raise. If she receives a 5% raise, she anticipates an additional $2,265 per year ($188.75/month) after taxes.
Build Up Emergency Cash: One of the best ways to get yourself back into credit card debt is to not have some money in reserve. If you don’t have a short-term emergency fund stash (think $500-$2,000) you’ll want to set that aside before you start paying down the debt in earnest. You’ll also want to start putting money away toward a longer-term goal of 3-6 months of saving. This is also a good time to plan ahead for things like car repairs or annual insurance bills.
The Smiths’ Step: The Smiths plan to set aside $1,000 from the tax refund they expect to receive to help them establish an emergency fund, and they plan to put $100/month from Mrs. Smith’s raise toward their longer-term emergency fund goal.
Lower That Interest Rate: While 16% may be the average rate for interest on a credit card, it’s still very high (and very expensive) compared to other types of loans. If you’ve consistently paid your bills on time and have used the card responsibly, begin by calling your credit card company and asking for a lower rate. It’s helpful to research other cards you might qualify for so they know you might take your business elsewhere. You might need to try a few times to get someone who will work with you. If you can’t lower your interest rate on your current card, you might decide to transfer your balance to another card with a lower interest rate. Note: Transferring your balance could impact your credit score since credit history is something that’s factored in. You’ll also want to look closely at the terms of the balance transfer to ensure that the introductory rate will extend through your entire repayment period. Check out this Nerdwallet article to learn more.
The Smiths’ Step: While the Smiths were not able to get their credit card company to lower their interest rate long-term, the company did agree to temporarily lower their interest rate from 16% to 13% for one year.
Create a Plan: Now, it’s time to put all of the pieces together. If you have just one card, you can create a plan using a simple calculator based on the amount of income you can pay each month or the desired repayment time. However, if you have more than one card you’ll need to be a bit more strategic. A calculator like this one from Magnify Money can help you to evaluate whether the snowball (paying off the card with the lowest balance first) or avalanche (paying off the card with the highest interest rate first) strategy is right for you.
The Smiths’ Step: After applying the remaining $1,827 from their tax refund, they only have $4,179 to pay off. Their increased income and reduced expense savings give them an additional $296.75/month ($100 shopping + $108 vacation savings + $88.75 remaining from the raise) to put towards their debt on top of their minimum payment. With the help of their new interest rate, they will be able to pay off their debt in eleven months paying only $256 in interest — way to go, Smiths!