This article, “Pay Off All Credit Cards and Consumer Debt,” is the third in a five-article series that discusses the Five Fundamentals of Fiscal Fitness. The Five Fundamentals were designed as a basic starting point to help you take control of your finances. If you do nothing else, following the Five Fundamentals will help you ensure that you are able to live within your means. There should be more to your financial plan than the Five Fundamentals, but following them allows you to move beyond living paycheck to paycheck, and focus on longer term financial goals, such as retirement planning, or saving for a specific goal, like a home purchase.
There are a lot of people who feel this topic is a no-brainer. Sorry guys, we’re going to cover it anyway, because eliminating consumer debt is an important part of the Five Fundamentals. People who aren’t able to tackle their credit cards and other consumer debt (think long-term expensive car loans, signature loans, home equity loans with no purpose, etc.) will not be able to graduate beyond the paycheck-to-paycheck mentality. So, with that said, let’s talk about paying off consumer debt in general, and credit cards in particular.
While debt can be a good thing (leverage is the primary reason 99% of Americans own a home, for example), consumer debt is by definition, a very bad thing. There are several things to consider about consumer debt:
- Appreciation vs. depreciation. It’s one thing to leverage debt to purchase a home, or a college education, the values of which will rise over time. However, it’s generally bad to finance a purchase that depreciates over time. In some cases, such as a car purchase, you might not have a choice, but you should still be prudent as to how you use an auto loan.
- Interest working in reverse. Wise investing takes advantage of compounding interest, which over time is one of the most powerful drivers of financial success. Consumer debt works to the advantage of the lenders, making them rich over time by putting more of YOUR money into THEIR pockets.
- Inertia of money. People who save, invest well, and have good financial habits will continue to do so. Conversely, people who are inclined to rack up debt often end up in a position where they feel there’s no way out, or they end up leveraging themselves in one place (like a second mortgage) to pay off another debt (credit cards). While refinancing can be a good strategy to pay down debt, a lot of people never get out of it because they seem to find an ’emergency’ that causes them to take out more debt along the way.
- Psychology of money. Did you ever go on a diet and say to yourself, “I already lost 25 pounds, and I only need to lose 5 more. I’m going to reward myself for all the hard work I’ve done?” Have you then thought about why it’s so hard to lose that last 5 pounds? It’s the same way with money. Think about all the hard work you’d put into paying off $10,000 in credit card debt, then treating yourself to a vacation when you’re done. You reinforce the bad habits that got you into the situation in the first place, which leads to my last point.
- You have to commit to breaking the bad habits that got you there in the first place. Paying off all of your debt doesn’t do a thing for you if you don’t change your spending habits. You’ll just end up back where you were.
Credit cards are the epitome of everything wrong with consumer debt. However, they’re much worse than many other forms of consumer debt. Why? Here are a couple of reasons:
You can’t reach into your back pocket and pull out a pre-approved car loan. You can, however, tap into $10,000 or $20,000 in instant credit to buy whatever you want.
Your ability to get a credit card isn’t based upon your ability to repay it. If it was, do you think you’d start getting pre-approved credit card offers in college, when you don’t have a job? No. Credit card companies know that the vast majority of people are scared to death about having any bad marks on their credit reports, and are perfectly willing to write off debt from a few bad apples so they can suck people in early.
Credit card debt is usually a much higher rate than most debt. Unless you’re talking about a payday lender, credit card debt is about the highest percentage debt you can obtain, because it’s not secured by collateral. Unlike a collateralized loan, where the lender can repossess a car or a house, a credit card lender can only recoup their money by passing the costs onto other credit card holders…which is why your interest rates are so high.
What Do I Do About My Consumer Debt?
If you’re truly serious about paying down your debt, you need to do several things.
First, you need to identify spending habits that got you here in the first place. Are you (or someone in your family) a shopaholic? Do you feel the need to reward yourself for getting things done by buying stuff? Do you feel ‘entitled’ to buy stuff because ‘you deserve it?’ These are all habits that perpetuate consumer and credit card debt.
Commit to stopping those habits. It will be hard. However, you need to sit down, and be honest with yourself about it. You’ll never make any progress (or you’ll erode the progress you do make) by just paying your debt without breaking bad spending habits.
Make a plan to pay down your debt. It’s like an elephant eating a snake…you don’t have to do it all at once. You just need to:
- Figure out what you can afford to pay. Make this more than the minimum payment..the more you can pay, the better.
- Prioritize your highest to lowest interest-rate loans & credit cards. Commit to putting the bulk of your money towards the highest rate loan or credit card. Once it’s paid off, roll those payments to the next highest rate item. Over time, you’ll see a snowball effect that compounds in your favor.
- Stick to the plan.
Commit to paying cash for everything. It’s tough, but proven. Cutting out everything that involves purchasing on credit, and sticking to paying cash does work…if you do it. Some people find that using pre-paid debit or credit cards works for them as well. As long as your purchases don’t add to your debt situation, use cash, check, or pre-paid cards.
You might need to get help. Find your installation’s financial counselor. If you think you know what you’re doing, you might want to just run your plan by the counselor to see if there are any adjustments you need to make. Or, you might need someone to help you completely design a debt management plan from scratch. Either way, make a commitment to yourself that you will see the counselor on a regular basis (every 3 months or so), just to hold yourself accountable. Accountability is key to making this plan work.
Paying off credit cards and consumer debt is a cornerstone of the Five Fundamentals of Fiscal Fitness, which are designed to help establish the foundation for your financial success. If you’re not able to tackle your debt and eliminate it, you’ll never be able to find enough available money to establish a solid financial position, much less reach your financial goals. In the next article, we’ll discuss how important it is to own the right-sized house and the right-sized mortgage.
So, how much consumer debt do you have? If the answer is zero, that’s great! If you had to work really hard to get to zero, please tell us your story in the comments section! Also, feel free to subscribe to this blog if you’d like to automatically receive future posts via email.
I hope you liked the Five Fundamentals of Fiscal Fitness.
Below are links to the other articles in the Five Fundamental series.
- Fundamental #1: Pay Yourself First
- Fundamental #2: Maintain Enough Liquidity
- Fundamental #3: Pay Off All Credit Cards & Consumer Debt
- Fundamental #4: Own the Right-Sized Home (& Mortgage)
- Fundamental #5: Invest In Your Career
Caveat: Five Fundamentals of Fiscal Fitness is a money management philosophy created by Bert Whitehead, a prominent thought-leader in the fee-only financial planning world. Bert’s philosophy has been standardized by the Alliance of Comprehensive Planners (ACP), a non-profit membership of like-minded, fee-only financial planners dedicated to helping clients avoid the pitfalls of the financial services industry. Disclosure: I am a dues-paying member of ACP, and fully believe in the five fundamentals of fiscal fitness. Please feel free to contact me with any questions you may have about ACP and its philosophies.