Steps to Paying Off Credit Card Debt

One of the biggest challenges for new investors to overcome when they first decide to start building wealth is a mountain of credit card debt built up over several years. With balances of $10,000, $20,000 or more, at 20 percent and 30 percent interest, they find themselves paying upwards of $500 per month in interest expense alone, never actually paying down the balance of the credit card debt, which adds even more frustration and pain to the cycle. Tens of millions of Americans live free from the burden of credit card debt and there's no reason you can’t be one of them.

Stop the Blame Game Over Your Credit Card Debt

Many people can benefit from learning to accept responsibility for their own financial life and take control over their credit card debt. It’s easy to blame others, the economy, the economic system, political system, their boss, or anyone else for their debt load.

However, if you don't accept any responsibility, that means it's someone else's fault and there's nothing you can do to fix it. Once accepting that your debt is your own responsibility, you'll realize you have the power to do something about it.

You might have made some unwise choices in the past, not realizing that every time you swiped your credit cards, you made a willing decision to borrow money you did not currently have. The very first month the statement came and you couldn’t pay off the entire balance in full, you had exceeded your financial resources, and that's when the trouble starts.

What's the good news? If you got yourself into credit card debt then you have the power to get yourself out of it. It’s that simple. The moment you can look into the mirror and say, "it's my fault" and truly own the situation, you can begin to turn it around just like millions of people before you have done.

Stop Segregating Your Income Mentally

Many people have substantial credit card debt and seek help on how to get out of the situation. Although many resources exist including credit counseling, classes and online courses on debt management, nothing helps until the person makes a real commitment to get out of credit card debt.

While they dislike the payments and dream of the day their credit card statements show a $0 balance, wishing for something and doing something to proactively to make it happen are two entirely different things.

Suppose your neighbor, Jason, makes roughly $75,000 per year and has $22,000 in credit card debt. This debt is overwhelming to Jason and he spends at least a few hours every day worrying over the $500-plus per month in interest payments he pays just to stay on top of his current balance.

Yet, at least once a month, he spends $150 at the local casino. When asked about it, he says that there are certain things that he won’t give up no matter how bad his debt situation.

Jason might never get out of credit card debt with this attitude. The extra $1,800 per year he’s spending at the casino would pay down $9,000 of principal over five years, or nearly 41 percent of the balance.

If he could make an extra $50 per week either by working more hours or cutting costs, like ride a bicycle to work instead of driving, he could pay off an extra $13,000 in principal over those same five years. That’s all it would take to obliterate the balance.

Instead, he partitions his income into “my casino money” or “my grocery money.” However, you have one lump sum of money available to you. If you are in credit card debt, paying massive interest on your balances, take every extra penny you can and pay down the debt.

Don't Use a Home Equity Line of Credit to Pay Off Credit Card Debt

Many financial planners will tell you to use a HELOC, or home equity line of credit, to pay down high-interest credit card debt. However, if you must declare bankruptcy in the future, your credit card balances are unsecured, while a home equity line of credit is secured by your house.

Why does this matter? Because it means that you’ve taken a debt that was backed only by your credit, where the worst a credit card company can do is go to court and get a judgment against you, and have now turned it into a debt backed by your home, where the bank can foreclose on your home and put you and your family out in the cold.​

If your credit card debt is manageable, and you just want to save a few thousand dollars in interest expense, a home equity line of credit might make sense. If you think there’s even the remote possibility that you may be forced to declare bankruptcy, it can be a tragic mistake that costs you your house.

Sell Any Unrestricted Investments You Have to Pay Off Credit Card Debt

It's almost always a better choice to lower your debt levels than contribute for retirement if the interest rate you are paying on debt exceeds 10 percent to 12 percent and is not tax-deductible.

If you have any non-restricted investments, you may want to sell them and pay down your credit card balances. Be careful which ones you sell, though, because you don't want expensive tax consequences on top of your current debts.

 Consider a 401(k) Loan to Repay Credit Card Debt

If you have a 401(k), consider taking a loan from it, because the interest you pay on it will go into your account as you are effectively paying interest to yourself. You can avoid the income taxes and 10 percent early withdrawal penalty for withdrawals as long as you repay the loan within the time frame allowed by the IRS. You would not want to sell 401(k) assets to pay down your credit card debt because the IRS will assess the early withdrawal penalty..

 Take Back Roth IRA Contributions

IRS rules allow you to withdrawal Roth IRA contributions you’ve made into your account, but not the gain earned on the money. In other words, if you’ve deposited $20,000 into a Roth IRA over the past 10 years and have made $10,000 in profit, you can take back up to $20,000 without any tax penalties or consequences, although you'll lose the chance to grow your money outside of the reach of Uncle Sam, but that’s far better than drowning in high-interest credit card debt.

 Brokerage and Other Investment Accounts

Investments you hold in regular brokerage accounts such as stocks and bonds will be subject to regular capital gains tax but the emotional release that comes as you pay off a big chunk of your credit card debt should be far less painful than the cut taken by the IRS.

Pay Off the Lowest Balance Credit Card Debts First (aka the Snowball Technique)

Taking control of your financial life means finding ways to increase your cash flow each month. The more excess cash you have, the more you have to reduce debts, save for retirement or spend on improving your lifestyle.

Each debt has a minimum monthly payment. By paying off the lowest balance credit card account first, you remove an entire fixed payment, instantly making your existing money stretch further.

Next, take the money you were paying on the lowest credit card debt balance and send it in to the next lowest. Repeat this process until you are left with your single, biggest debt.

This practice is known as “snowballing” in the financial planning industry because the amount of money you send in to each payment gradually snowballs as each debt is reduced until you are sending in large amounts of cash to attack your biggest, and last, debt

For example, if you had a $10,000 balance on a Bank of America credit card, a $3,000 department store credit card, and a $1,000 gas station credit card you would pay all of your extra money to the $1,000 gas station card.

Once this debt was removed, you'd take all of the money of that money and attack the $3,000 department store card. This cycle repeats until you've repaid all of your debts. It's an effective way to reduce and pay off credit card debt and it’s easy to understand.

Make Micro Payments to Reduce Credit Card Debt

snowflake technique paying off credit card debt
The snowflake technique is designed to help you pay off credit card debt by sending in so-called micro-payments. These payments can literally be a few dollars and, over time, add up to big balance reductions, saving you thousands in interest expense. Getty Images

As an alternative to the snowball technique for reducing your credit card debt, you can try the so-called snowflake technique. Every time you get more than a few dollars in your hand, send it in to your credit card company to reduce your outstanding balance.

It doesn't matter if you make a payment for $7.12, $14.35, or $3.54. If you just put that money in the bank, it will get spent. That's human nature. Even If all you can find is an extra $2.74 per day to pay on your cards, that's still a whopping $1,000 per year taken off your credit card debt balances.

People often ignore the power of small amounts. There is a compounding effect that goes to work. It's not unlike the Indian story of the ant that was able to move an entire mountain, one grain of sand and piece of dirt at a time. Your small efforts may not look like they're even denting your credit card debt. In the aggregate, though, over the years, the results will be nothing short of spectacular.

Cut Up Your Credit Cards (or Make Them Inaccessible)

frozen credit card debt
One technique for reducing credit card debt suggested by financial planners is to freeze your cards in blocks of ice, helping you avoid the temptation of non-essential purchases. Getty Images

Years ago, a financial planner told clients to freeze their credit cards in blocks of ice. When they were tempted to spend, they would be forced to melt the ice, giving them time to rethink impulse purchases. An even better solution is to cut up your cards entirely so that you can’t charge anything else to them.

You might exclaim, “But I can’t pay my bills without a credit card! That means I don’t eat.” This may sound harsh, but the reality is, you’re not paying your bills. The credit card is merely allowing you to postpone your bill paying and helps ensure that when it does come, it will be much worse.

Personal finance expert Dave Ramsey calls cutting your cards up a "plasectomy" and says that cutting up your cards and paying off your credit card debt works, but only if you commit to never using credit cards again. In Ramsey's eyes, credit card debt is nothing but a symptom. It means you've been buying things you likely don't need, with money you don't have, and it's your mindset and habits that need to change.

Get a Part Time Job or Work from Home

You may have committed to getting yourself out of debt. Let's say you're determined that within one year, you're going to have paid off all debts, including that brand new car you just recently purchased.

You get a weekend job as a waitress on top of your day job, save every penny after taxes and use it to pay down the balances on your accounts. You temporarily put all investing on hold, including retirement contributions, to achieve your goal.

Suddenly you find, with six months still to go, that you're going to easily meet your goal. By introducing more money into the equation, you been making large additional payments on your debt, paying less interest on your outstanding balances and accelerating your debt payoff.

When the year's up and you're done paying off your debt, your monthly income will go up without a single additional hour of work. In effect, you'll be giving yourself a pay raise.

The point is a powerful one. There's nothing you cannot accomplish if you focus and accept the sacrifice necessary to achieve it. In this case, that’s a year of extra weekend work to give you a clean credit slate and more opportunities.

Years from now, you may look back and realize that this twelve month period was what allowed you to go after your larger goals and dreams, which might even include adventures such as launching your own business.

As the old saying goes, until the pain of staying the same exceeds the pain of change, you’re unlikely to move.

The Nuclear Option for Credit Card Debt – Bankruptcy

In the world of personal finance, the “big red button” is bankruptcy. In many cases, it is possible to completely eliminate credit card debt with a bankruptcy filing, or at the very least have a court-ordered restructuring that gives you breathing room with lowered payments so you can get your life back in order.

The opportunity cost of such a move is that your credit will be ruined for up to ten years, although most of the damage fades after seven years.

For some, bankruptcy really is the best and most effective option for discharging credit card debt. It allows you to start over, almost like hitting “reset” on a video game. One drawback to consider is that the bankruptcy rules can force a lot of middle-class workers to file Chapter 13, which reorganizes your finances and you'll have to agree to pay back the debt from future earnings.

This is less advantageous than Chapter 7 bankruptcy, which allows you to wipe out your debts completely. Congress is currently working on laws to improve this situation.

Credit card companies know that you can discharge your debt through bankruptcy. Sometimes possible to get them to drastically lower your interest rate simply by explaining to them that you want to repay your debt, but unless they modify the current terms, you see no alternative but to declare bankruptcy.

You may have to spend a good deal of time on the phone, escalating from supervisor to supervisor, but ultimately you have a good chance of going from 30 percent credit card interest to around 13 percent.

If you are emotionally exhausted, want to start over, and are willing to go through the process of bankruptcy, seek out a highly regarded, qualified bankruptcy attorney in your area. They can explain the drawbacks, costs, benefits, and process to you. In some cases, it might be better to clean the slate and start over to begin rebuilding your financial life.

The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.