The question of whether to meet your savings goals every month or focus on debt repayment is a common one and can lead to difficult choices, especially when money is tight.
Understanding Credit Card Debt
Though credit card debt is only a fraction of total household debt in the U.S., it’s a key place to focus in debt reduction because of its flexibility in payment terms, such as the ability to make minimum payment terms indefinitely. It’s also a great place to focus because of the typically high interest rates associated with credit cards. While it can be tempting to make those relatively small minimum payments, your balance will still be there and will have to be paid off eventually.
What About My Credit Score?
Obviously you’ll want to avoid missing scheduled credit card payments in order to optimize your credit health. Keeping your credit card balances at a reasonable amount for your income situation is important.
Typically, once you go past 30 days on a scheduled payment, card issuers may report the past due account to the major credit bureaus – Experian, TransUnion and Equifax. Once a late payment hits your reports, your credit score will most likely drop.
Should I Use My Savings to Pay Off Credit Card Debt?
Setting up an emergency fund is a very important strategy to prepare for unexpected expenses and for overall debt management. But how do you weigh the choice between paying down credit card debt vs. maintaining an emergency fund?
Generally, building an emergency fund should be your priority since it’s called an emergency fund for a reason. Your unique financial situation and goals will ultimately determine your choice.
A good rule of thumb for prioritizing your emergency fund includes several scenarios. Focus on it if you don't yet have one, only have manageable "good debt," or wish to avoid new debt that could impact future expenses.
On the other hand, you should consider paying down credit card debt when you are faced with an immediate payment obligation, you don’t want to increase your high-interest debt, or you have a short-term need to preserve or improve your credit score.
Credit Card Rules to Live By
Now that we’ve discussed some of the pros and cons regarding savings and debt reduction, let’s turn our attention to strategies that can keep your credit card debt to a minimum before it gets out of hand.
- Pay your balance every month
Credit card balances should be paid on or before the due date. Paying the balance in full has great benefits. If you wait to pay the balance or only make the minimum payment it accrues interest. If you let this continue it can potentially get out of hand and lead to debt. Missing a payment can not only accrue interest but hurt your credit score. - Know your APR and other fees
Every card is different so make sure to read the fine print, so your fees don’t start to add up. - Build a solid credit history
If you’re new to the credit card world, getting a card with a low limit or a secured card is smart. Then you can start paying the balance in full and on time every month. This is a great way to establish credit. - Incorporate your credit card into your budget
Understanding how to use credit cards is a wise part of budgeting and they can be very helpful if you use them correctly. With a good understanding of your budget, you can better manage your spending and credit card payments. - Spend mindfully
Credit cards make it easier for us to make purchases but unfortunately they also make it easier for us to overspend. Focusing your purchases on necessities can go a long way in helping you stay on budget. - Understanding Credit Card Rewards
Understand your rewards as a large factor when choosing a credit card. Those rewards can be used to bolster your savings account or pay down debt.
How Do I Manage My Debt Better?
As we discussed earlier, debt management goes well beyond credit cards, so a more comprehensive approach needs to be considered.
- Make a list of all of your outstanding accounts, payment schedule, interest rates and payment terms.
- Check your credit report for accounts you have but haven’t thought of or accounts that you don’t recognize or aren’t active.
- Look for opportunities to open up a debt consolidation loan. If you have multiple high-interest loans, can you consolidate them into one loan with a lower interest rate?
- Determine how much debt you have and how much you have to pay each month, quarter, year or one-time. If the amount is more than you can manage with your income, you might contact your lenders to see if you can get friendlier payment terms.
- Determine how much money you have left in your budget to prioritize debt reduction.
- Determine your debt-reduction strategy – pay off accounts with the highest interest rates, which is the best long-term strategy, or pay off the lowest balances first, which is the best way to make quick progress.
Spending Habits and Your Financial Goals
You have short-term and long-term financial goals that take your retirement and lifestyle needs into consideration. Your spending habits will greatly determine how easy or difficult it will be to meet those goals, or if you will meet them at all.
Be honest about your spending habits, especially if your debt starts to feel overwhelming, then take action.
How to Break Bad Spending Habits
Making a few good decisions over and over will set you up for long-term success. So now that you’re aware of which spending habits have got to go, here’s what to implement instead.
Get on a budget.
Give every dollar a name at the beginning of the month—and pay yourself first. Without savings to cover an emergency, your financial security is at risk, and you’ll be tempted to use a credit card when the car breaks down.
Understand yourself and your motivations.
Every single day, you have the power to make decisions that will move you forward financially or set you back. Knowing your strengths, trouble spots and tendencies is key to using them to your advantage.
Meal plan.
Plan your meals at the start of each week to avoid paying an arm and a leg for fast food throughout the week. And when you do eat out, think twice before you add on an appetizer or a drink.
Wait before you buy.
It takes courage and wisdom to say no to purchases and make decisions based on what will drive you forward, not what pleases us in the short-term or makes us more pleasing to other people.
When we think about smart financial decisions, we often think about saving, investing and lowering our tax liability. However, often the most powerful thing we can do is get our spending and debt management in a good place, and credit card debt is a great place to make progress.
Finally, it’s always important to be educated about financial issues, but it’s also important to seek financial advice about your unique solutions from an expert in the field.
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