How Do I Get Out of Credit Card Debt and Start a Budget? (Updated Sept. 2023)

How Do I Get Out of Credit Card Debt and Start a Budget?

Topics: Lifestyle reduction, track spending/budgeting, make drastic changes, set a goal; credit card optimization

In my first post I asked the question: Why Should I use a Financial Advisor for Asset Management?

This week’s question is perhaps more sensitive and more difficult to answer. Frankly it’s a tough question to ask. Debt can be a useful tool to get you into your first home and start the process of building home equity and wealth. However, it can be a tremendous burden if you have amassed high-interest rate credit card debt and now just making minimum payments is stretching the budget. It may be a long path but the best thing you can do today is create a plan and goals, which can at least provide some level of comfort. Email me! matt@mhb-advisory.com.

As we mentioned in our most recent blog, more than half of respondents to a recent survey couldn’t come up with $1,000 in an emergency. Statistics suggest consistently over half of all credit cards have a balance carried over while nearly two-thirds of respondents to a recent survey say at some point they carried a balance on their cards. In fact, we as a country now for the first time ever have credit card debt of more than $1 trillion!

Back to a more personal level, I’ve not heard a single anecdote where parents advised their children to get into credit card debt. It’s more that parents avoid the conversation around saving vs spending and debt in this form is accumulated because consumers are unaware of the long-term consequences of spending money now and paying for it later. Or perhaps there is a genuine emergency and adequate savings were not available. Either way, a habit relying on credit cards is easily formed. Interest payments continue, savings rate suffers, and the cycle perpetuates. However, now is the time for a new start!

So…How Do I Get Out of Credit Card Debt?

In order to break the habit, a change in mindset is required, employing self-discipline and delaying gratification to make decisions based on economics, not emotions. Whew! That sentence alone is a lot to process. Below are our 4 Steps to Eliminate Credit Card Debt:

Lifestyle reduction

Admittedly, this will be the hardest part. If credit card debt is part of your life and has been slowly creeping higher, you will have to adjust your lifestyle. You will have to cut back on things that have been part of your life so your debt will stop growing. Sorry to be blunt, but if you can’t pay for it with cash right now, you shouldn’t buy it. You will need to make some sacrifices. This might require you saying NO. No to dinner, No to travel, No to coffee or drinks with friends. Cutting your expenses sounds great, but where do you start? Read on.

Track spending to form a budget

If you don’t have a budget, you should track your spending to know where your dollars are going – check out our Free Budgeting Tool (https://mhb-advisory.com/financial-freedom). Once your spending is understood, establish a budget (more info below) and eliminate unnecessary expenses. Make it realistic based on actual spending then find areas to trim the fat. Cutting out a latte a day sounds great, but big-ticket discretionary items like travel and dining are often the biggest culprits. Furthermore, your living situation, groceries and transportation, although all are generally considered as “needs”, are often your biggest monthly expenses, so any significant change in those categories can accelerate your path to being rid of credit card debt for good.

Find a catalyst

If you take a gradual approach to making changes, you will gradually see changes. If you want to see drastic changes, you must make drastic changes. To accelerate your credit card paydown, the option of selling assets can be a great source of cash. Examples of drastic changes include changing your living situation or selling your car. Less drastic measures might include selling furniture or other unused items. It may not be worth selling a car where you owe more than its worth, putting you in a worse liquidity position, but downgrading your lifestyle by selling assets can meaningfully help kickstart the process of getting out of debt.

Set a goal, have a plan

Find a reason to eliminate credit card debt and save: maybe for a new house, retirement, college planning, debt-related stress and tiredness. Then wherever you are in terms of debt burden, once you have examined your budget and jumpstarted the process, set a goal: “If I have $15,000 in debt and direct $500 a month to debt reduction, I can be debt free in two and a half years!” But you have to stick with it. You should also consider consolidating debt onto a 0% interest credit card for a fixed period, which can save thousands of dollars of interest (move $6000 to such a card and commit to paying it off in 12 months - $500 per month). Of course, if you don’t pay off the balance in that timeframe, then the exercise is a waste of time. If you continue to use your credit cards, you must have a clear strategy long-term (commit to using only one card, pay off balance every month, only use for certain items, etc.). If you can’t stop overspending, then you should explore going with the all-cash option and getting rid of credit cards.

So…How Do I Start a Budget?

In terms of budgeting, one rule of thumb is the 50/30/20 rule, which suggests spending 50% of your income on your needs (mortgage/rent, food, transportation and any other bills you are contractually obligated to pay – credit card minimums, medical bills, cell phone), 30% on discretionary items (fun stuff like dining out, entertainment, travel), and 20% on savings or debt reduction. Add back any pre-tax retirement contributions to your take-home pay to get an adjusted net pay for the calculation. And include pre-tax savings in your 20% savings bucket.

One problem here is that debt reduction and saving fall into the same bucket, so while you may be hitting your 20% target, you might also not be saving any money if you have significant consumer debt. I would include giving in the 20% bucket or possibly the 50% bucket. Furthermore, there is some overlap here as you do have “discretion” among your biggest needs – what kind of house, what kind of car, where do you eat, etc. So, a few additional thoughts on those three items:

Living details: If you have no mortgage like 30% of America and just have to come up with insurance and property taxes each year, then kudos! Hopefully your saving and investing bucket is the beneficiary. For the rest of us a fair target budget is 20-35% of your income for living expenses. If you are renting, perhaps your goal and motivation is home ownership (credit card reduction is a great start!). It isn’t for everyone, but if you can get there, I believe this is a meaningful step toward building wealth, maybe the biggest. Ideally, a 20% down payment and 15-year mortgage will be the best options and the best gauge of what you can afford, but the 30-year has the advantage of lower monthly expenses. Paying private mortgage insurance due to a sub-20% down payment is sub-optimal long-term, but okay getting started.

Food details: This area can be tricky – some people like to cook, some don’t. There are plenty of pre-packaged meal kits or delivery options, but your best bet still is buying goods from the grocery store and making it at home. If this is a struggle, plan your meals weekly, buy exactly what you need and plan the number of times you will go out to dinner on a weekly basis. If one dinner out is $200, next time take the less expensive option, or the BYOB restaurant. Meal planning can help you avoid the random mid-week fast food pickup as well.

Transportation details: While things like insurance, registration, oil changes and other maintenance are not discretionary, the choice of car is, and thus presents an opportunity to save money. If your automobile payments seem excessive or creating the need to rely on credit cards for other spending, your mode of transportation might be worth an examination.

See below for a budget example, but I think the goal must be to get your spending somewhat close to the 50/30/20 targets using your REGULAR INCOME. This is important (and not easy to do). You will be much better off using bonus dollars and extra income for EXTRA things – travel, debt reduction, extra investment. Planning on taking a 10-year anniversary trip to Jamaica? Don’t do it if you haven’t saved for it or didn’t get a bonus to cover it.

Credit Card Optimization

I would be remiss to not discuss the use of credit cards as a tool. I have gone through this exercise after not thinking about the benefits of credit cards for several years. While I used to get excited about frequent flyer miles, blackout dates and the $100 fee to use my “free flight” became too bothersome, so I prefer getting cash back and paying for my flights with dollars. That being said, there are enough zero-fee cards available that you can get at least 2% cash back on anything you purchase and 5% on some necessities like groceries, gas, wireless/internet cable, etc. You can find cards offering somewhere in between 2-5% on every other thing you spend money on like entertainment, restaurants, coffee shops and travel without carrying 10 credit cards.

Depending on what’s important to you and where you spend money, I estimate a couple hours of online research (https://www.nerdwallet.com/the-best-credit-cards) and filling out applications can probably generate another $1,000 a year in savings. You can get better short-term cash back (or miles) if you are willing to chase deals and jump from card to card every few months, but that level of work is not worth it to me. I’m making decisions for the long-term with my investing and my credit card optimization, but this is an opportunity to do what’s best for you, assuming you can control your spending with credit cards.

In summary, I believe credit card debt and wealth cannot coexist. Making certain changes in lifestyle and expectations will be required to get rid of credit card debt, and if it remains a problem, then going to a cash system is necessary. However, change is possible, and we can help! To see more ideas related to budgeting connect with us to see our free tools: (https://mhb-advisory.com/financial-freedom).

If you or someone you know has any financial-related questions, I would love to have a conversation, so please feel free to reach out: matt@mhb-advisory.com.

And please don’t forget to view our prior blog (Why Should I Use a Financial Advisor?) and stay tuned for upcoming blog posts where we discuss maxing out your 401k (or not), paying off your mortgage early (or not), and what early retirement might look like.

Best wishes on your financial path!

Matt

P.S. For more info related to credit cards and coronavirus check out the resources below:

https://www.creditcards.com/credit-card-news/credit-card-issuers-relief-coronavirus/

https://money.com/best-credit-cards/

This post was created by Matt Beeby, the Founder of MHB Advisory Services. Matt has been working in Financial Services and investing in real estate since 2005, though his investment experience spans nearly two decades. He is a Christ follower, active in both his church and his neighborhood association. Matt enjoys sports and family time. Read more about Matt on his website bio.

Disclosures:

Information contained in this document is for informational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any product or security.
This information is believed to be accurate and should not be considered tax or legal advice.
Please consult tax or legal professionals for such advice and be sure to consult with a qualified financial advisor and/or tax professional before implementing any strategy discussed.
Investments involve risk and are not guaranteed to appreciate, and past performance is not indicative of future results.
Additional information including our privacy policy and Form ADV are available on request or can be found on our website: mhb-advisory.com.

Sources:

https://www.lendingtree.com/credit-cards/credit-card-debt-statistics/

https://www.thestreet.com/personal-finance/credit-cards/average-credit-card-debt-14863601

https://www.nerdwallet.com/blog/average-credit-card-debt-household/

https://www.discover.com/credit-cards/resources/average-credit-card-debt/

https://www.magnifymoney.com/blog/news/u-s-credit-card-debt-by-the-numbers628618371/

https://www.creditkarma.com/advice/i/50-30-20-rule/

https://www.nerdwallet.com/the-best-credit-cards

Photos: https://unsplash.com