Ouch. If you find yourself in a financial situation like that described above, owing a great deal of money on credit cards with an interest rate above 10%, juggling debt, making minimum payments, and progressively climbing further into debt, with interest and penalties costing you more and more every month, you are not alone.
If you are carrying debt on one or more credit cards, you are making the credit card company rich, while keeping yourself in debt. You know its time to break the cycle, but starting the process of getting out of debt permanently is a difficult process that requires a great deal of mental and emotional fortitude. But you can live debt free. For an excellent resource explaining many of the steps below in greater detail, try reading The Total Money Makeover: A Proven Plan for Financial Fitness, by Dave Ramsey.
Your Step by Step Guide to Paying Off your Credit Cards:
Make the decision. The first and most important step in paying off your debt, is to make a long term commitment to yourself, your family, and your future. This must be an all encompassing lifestyle change, in which your entire family needs to be involved. In the beginning, it will hurt, as you and your family adjust to living within your means. But take heart that it will hurt more in the beginning, and that if you can stick with the plan, you will be happier, richer and more fulfilled as time goes by.
Stop using credit cards. This is going to be tough, especially if you do not have a working budget. Take your credit cards and hide them. Give them to a relative, lock them in your safe deposit box, or have a friend hide them in your house.
Build a budget. If you don't already have a budget, you need one. There are numerous easy ways to start a working budget. Possibly the easiest and most sustainable is to use the "cans" method. Find a coffee can, and label it with a budget category. At the beginning of the week, put a predetermined amount of cash in the can. That is your weekly budget. When the money runs out, you can no longer spend on that category.
Know what you owe. Take stock of your outstanding debt, and order the debt from smallest to largest amount in a spreadsheet, on a piece of paper, or whatever you have handy. Since you have already stopped using credit cards, the sum of these accounts is now your owed principle.
Call your creditors. Call your creditors and request lower interest rates on existing balances. They may or may not accept your request. Usually, threatening to transfer your balance to a card with a lower interest rate may bring about a decreased interest rate from your card company. If this technique still doesn't work, you may want to shop around for a card and actually transfer the balance on your highest interest debt.
Pay the minimums while you fund your emergency account. Build up your emergency fund (in a high interest online savings account like ING Direct), while making the minimum payments on your outstanding debt. This step will be painful as you will now see the effects of interest payments on your outstanding debt, but it is imperative to long term financial health to have an emergency fund.
Keep in mind, if you don't have an emergency fund, all it takes is one setback to put you back on the debt treadmill. Once your emergency fund reaches your determined threshold ($1000 is a good starting point at first), you will be ready to begin paying off your debts one by one.
Start paying off your debt. While making the minimum payments on all of your accounts, choose the account with the lowest balance. After looking at your household budget, apply the maximum amount of available money to repaying this account. You will continue to do this every month until the first account is paid off.
Begin snowballing your debt. Once your first account is paid off, you will take the payment you have been applying to the first account, and steamroll it right into the account with the second highest balance.
Repeat the process. Continue this process, focusing on one account at a time, working from the smallest account to the largest. Be patient, stick with the plan, stay within your budget and this debt elimination strategy will work in your life.
This strategy is a very watered down version of what you will find in The Total Money Makeover: A Proven Plan for Financial Fitness, by Dave Ramsey. Ramsey certainly believes this to be the best way for average Americans to begin to break the bonds of credit slavery and offers a program with wonderful psychological rewards as you begin to see results immediately (which is why we start with the smallest balance, and not the card with the highest interest rate).
Getting out of debt is the first step in building a secure financial future. You will never get rich by paying someone else 15% or 20% per year, which is why getting out of debt is priority number one in your financial life. Paying off debt also offers the single best return possible inside or outside of the financial markets. No mutual fund or hedge fund manager could guarantee you a 20% annual return, but a 20% return is absolutely what you will get by paying off your high interest credit debt.