How to Pay Off Credit Card Debt – Part 2 (Develop a Plan)

This is part 2 of a 2 part series. Part 1 explains how credit card companies charge interest and stresses the importance of APR. Make sure to check out part 1 first – How to Pay Off Credit Card Debt, Part 1

This is not an easy guide to follow, it will take dedication and a complete shift in what you are doing now. There is no set and easy way to get rid of all the debt you have, unless you want to go the bankruptcy route which I highly advise against. Your credit will be ruined and it’s not being responsible. You created this debt, now it’s time to eliminate it.

Stop Using Your Credit Cards

First at foremost, you need to prevent your debt from growing any larger. Do whatever you have to do to avoid using them, get a hold of yourself! Take them out of your wallet, cut them up if you have to, call the company and place a hold on your cards, just stop adding to your problem. From this point forward you can no longer buy anything without having the money. Use cash, or debit only. I also would advise against using checks, get a debit card instead. It is very easy to write a piece of paper for a purchase when you don’t have the money. A debit card will be declined if you do not have the amount in your account.

Keep Track of Every Cent You Spend

Seems extreme? You bet it is. Plain and simple, you messed up your finances. You are are not resource intelligent. You need to start figuring out where your money is going. When you do this you can cut off the waste and funnel that money towards getting out of debt sooner. Seriously, write down everything, food, bills, toilet paper, alcohol, going out, dinner at Applebee’s, a movie from the video store, gas – everything!

This was one of the most interesting and beneficial experiments I have tried. It was a great learning experience. I never understood how I never had money even though I made more than enough to pay for my necessities. After just one month of writing down every single cent that I spent, it was clear how fast $10 here, $20 there adds up. I suggest doing this for at least two months or longer and I don’t plan on stopping anytime soon.

[Update – It is now March of 2010 and I have been keeping track of my spending since October of 2009. That is 6 full months. It has really helped me see where my money is going, but more importantly, how to cut out the waste.]

Write Down Your Debt

If you only have one credit card with a balance then this is easy. However, if you are like most people, you have a Visa, MasterCard, Discover, maybe an American Express, and they all may carry a balance. Gather your statements or call the companies and find out the following information:

Balance
Credit Limit
APR
Minimum Payment

After you have this down, now comes the planning. I think it’s best to give a real life example of my current credit card debt. Here is what I found after some organization:

Card 1
Balance: $2,978.67
Credit Limit: $4,700
APR: 22.24%
Minimum Payment: $70
Card 2
Balance: $1,848.84
Credit Limit: $2,500
APR: 12.90%
Minimum Payment: $45
Card 3
Balance: $1.970.10
Credit Limit: $2,500
APR: 15.99%
Minimum Payment: $50

That is a total of $6,797.61 in credit card debt, spread over 3 cards. Just staring at that number was pretty disheartening, and that may be the case for you as well, but just know that you can get out of it with a plan. Luckily I did not have any cards that were over my credit limit, and if you find that you do, make sure you carefully read the section Call Your Credit Card Companies below.

Don’t stop your research there, look for any credit cards you may have that haven’t been used in a while. I did this and found:

Card 4
Balance: $0
Credit Limit: $5,500
APR: 7.90%
Minimum Payment: $0

Card 4 had not been used for well over a year, but look at that beautiful APR rate. Card 1 was through Chase (with a 22.24% APR) and Card 4 was through Bank of America, and if you have 2 cards through different banks, you should be able to do a balance transfer. A balance transfer is simply one bank paying off your debt on the other card, charging you a fee, and moving the balance to their card.

I called about Card 4 and looked at my options. To move the debt from Card 1, I would be charged a one time fee of $120. Now at first thought it seems like adding more debt is something to avoid, but let’s crunch some numbers. If I were to pay $100 every month on my $2,978.67 debt, the differences are staggering if using Card 1 or Card 4:

Card 1 – 22.24% APR
Months to pay off: 45
Total amount paid: $4,373.30
Total interest paid: $1,394.63
Card 4 – 7.9% APR
Months to pay off: 34
Total amount paid: $3,326.54
Total interest paid: $347.87

Now as you can see, the $120 fee doesn’t look as large in the long run. Your APR matters. You may not find a card with a lower APR or a balance transfer may not be an option for you, but there are other options as well. You can apply for a new low rate APR card through a different bank. Even if you have a lot of debt you still may be accepted, although it helps if you’re on time with your payments. You can also ask your current card company to lower the APR on your card, and I will go into more detail on that later. You can do calculations like this yourself by using my Credit Card Debt Payoff Calculator.

Now that you have everything written out, it’s time to get a plan.

Organize Your Debt

As I showed, the balance transfer was definitely a good idea. If this an option for you, I highly recommend it. Now it’s time to look at all of your cards and decide which to pay first and how much to pay. Of course, the amount you are paying each month will depend on your income, but hopefully the process of tracking your purchases will help you stop wasting as much money.

As a rule, you should pay the cards first with the lowest balance and highest APR. This is because you will pay your debt off faster and rid of the cards that are charging you large fees. Card 4 has the highest balance and the lowest APR which means I will be charged the smallest fee and will take longer to pay off than the other cards. Because of this, it should be paid last. Cards 2 and 3 are similar, but Card 3 has a higher APR. Therefore, Card 3 should be paid off first.

As I said before, paying the minimum payments each month is not going to do anything. But since my debt was spread across multiple cards, it would have been impossible for me to be paying over the minimum on each card. This is another reason why there needs to be a focus. While you focus on one of your cards paying over the minimum, you can pay the minimum on the others. Then, when the first card is paid off, add that money to the second card, and repeat the process until the debt is gone.

After looking at our income, savings and spending habits, we (my wife and I) found we could put $500 per month towards paying off our credit card debt. Also, we had just gotten married, and took $1,000 from the wedding money and applied that to debt as well. If you have some extra money saved, it wouldn’t be a bad idea to use some of it towards your debt. I don’t think it’s a good idea to use all of your savings, as I recommend at least $1,000 always available for emergency funds, but it couldn’t hurt to get your balance down some from the get go if you have the funds available.

Our plan was simple, paying $1,000 down and $500 per month on our credit cards, starting with Card 3, then Card 2 and finally Card 4, until the balance was paid off. This worked out to $110 on 2 and 4 for minimum payments and $390 on 3.

What if you follow this and are still struggling? Well, it can never hurt to get a hold of the companies.

Call Your Credit Card Companies

This is something that most people never think of doing. Call the credit card companies, tell them your situation, and ask for their cooperation. Most of them will be surprisingly helpful. It makes more sense for them to work with you than to potentially never be paid. Ask for a lower APR, lower minimum payment, and explain your situation. Here is an example of what you can say:

Unfortunately I have found myself in an stressful situation and have more debt than I can afford to pay. But I want you to know I am trying to get out of this hole and could use some help. I have been working out a plan with my current income and everything will be settled much more easily if you are able to cooperate with me. Is it possible that you could lower my APR or decrease the amount of my monthly minimum payment? Without your help I’m afraid that the debt may simply too much and would appreciate your understanding. If we work together, I can see my debt being repaid within the foreseeable future.

Of course, you can tailor this script to your own style. If you lost your job or had to take a pay cut, let them know. You want their help, but do not act helpless, make it clear that you have a plan and are going to pay the debt off. If any of your cards are over the credit limit, you absolutely must get this taken care off ASAP. You can ask to have your your credit limit raised, or you can use some of your savings to get the balance down. You can even ask them to waive the fees while you pay what you can, do whatever it takes. Over limit fees are absolutely absurd and you will never be able to eliminate your debt with those added on to your interest.

If they say they are unable to help you in this situation, ask to speak to their supervisor. Once again, explain your situation, your willingness to pay back the money, and ask for their cooperation. It may seem like they wouldn’t want to help you since they may actually lose money by lowering your APR or minimum payment, but they know that if you end up having to declare bankruptcy they will receive nothing from you.

If they say no at first, do not take it for an answer. You do not have to get angry, just make sure they understand. After all of your trials, they still may not do anything. Don’t give up, call the next card company and after a month of paying your debt, call them back and go through the same process. Explain and show them that you are paying off your debt, actions are much louder than words.

It is important you get your APR lowered if at all possible. Just to get the point across of how important APR is, here are some more numbers. A card with a $3,000 balance and an APR of 16% paying $80 per month will take 53 months to pay off, totaling $1,186.87 in interest. If you decrease this APR just 3 percent to 13%, it drops to 49 months and $870.49 in interest, a difference of $316.38.

Time Line for Becoming Debt Free

So what is the time line for being debt free? With my plan ($1,000 down and $500 per month) and examples, this is what my final results will look like, compared to if I paid ONLY the minimum payments:

PLAN
MINIMUM
Card 3:
$1,000 Down, $390 per month
Months to pay off: 3
Total amount paid: $2,019.99
Total interest paid: $49.89
Card 3:
$40 per month minimum payment
Months to pay off: 81 (6 years, 9 months)
Total amount paid: $3,227.24
Total interest paid: $1,257.14
Card 2:
$40 per month until Card 3 is paid
$430 per month after

Months to pay off: 5
Total amount paid: $1,959.27
Total interest paid: $110.43
Card 2:
$40 per month minimum payment
 
Months to pay off: 65 (5 years, 5 months)
Total amount paid: $2,569.73
Total interest paid: $720.89
Card 4:
$70 per month until Card 2 is paid
$500 per month after

Months to pay off: 6
Total amount paid: $3,179.36
Total interest paid: $200.69
Card 4:
$70 per month minimum payment
 
Months to pay off: 51 (4 years, 3 months)
Total amount paid: $3,506.85
Total interest paid: $528.18
Total:
Months to pay off: 14 (1 year, 2 months)
Total amount paid: $7,158.62
Total interest paid: $361.01
Total:
Months to pay off: 81 (6 years, 9 months)
Total amount paid: $9,303.82
Total interest paid: $2,506.21

Quite the difference! There are some people who have much more debt than this, and some with less. However, the amount you have isn’t important right now. First, you must write everything down, then come up with a plan. I hope that my plan outlined above can help others in their journey to eliminating the stress of credit card debt. Make sure to check out my Credit Card Debt Payoff Calculator to help figure out how to start paying off your debt!

Now if only those student loans were paid off…

[Update – 3/23/10: Credit Card 3 has been paid off! On to CC2!] [Update – 2/23/11: Haven’t updated this in a while, here is my current situation. CC3 and CC2 have both been paid off in full. CC4 currently has a balance of $1,943.43. Based on the plan outlined, this should have been paid off this month. However, life happened and we had over $5,000 in medical bills pilled on us during 2010. So our monthly payment had to go down to compensate for that. We are currently paying $250 per month on CC4, which means it should be paid off in full around October of 2011. It sucks knowing that this would have been paid off by now, but what can ya do? Soon! :)]

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