10 Step Plan for Debt Elimination
I recently asked readers how to help my friend payoff his debt. I highlighted some of the responses in 7 Ways to Payoff Credit Card Debt.
Here’s the situation that he is dealing with (see the story for all the details):
- Personal Line: $3,500 balance @ 15% – $7,000 limit
- Credit Card #1: $2,300 balance @ 9.6% – $5,000 limit
- Credit Card #2: $6,600 balance @ 8.5% – $8,000 limit
- Credit Card #3: $1,900 balance @ 18% – $2,000 limit
He has $1510 available each month for payments and $9300 in company stock and upcoming bonus money available.
What I Would Do
I promised that I would put together a plan for him in paying off the debt. If it were me, here is how I would handle the payoff.
1. Pay the minimums on all cards.
It’s important to avoid late fees, overlimit fees and other penalties for not paying the minimum. Make sure that each month all minimum payments are made before any other strategies are used.
2. Evaluate the utilization percentages.
This is a key piece of debt paydown that many people skip. People often believe that they can’t get a new card with a lower interest rate; however, a few key changes to utilization could make all the difference (assuming there are no adverse credit report problems like bankruptcies, late payments, etc.)
Credit card #2 has used 82.5% of the limit and credit card 3 has used 95% of the limit. Ideally, his balance should be less than 50% on all cards; they should absolutely be less than 90%. Pay $980 on credit card #3. This will lower card #3 to less than 50% utilization.
3. Pay cards with highest interest rate.
After paying the minimum, and the high utilization card, use any leftover money toward the card with the highest interest rate. Each month, continue to direct all extra money toward the card that has the highest rate. First pay extra on credit card #3 at 18%, then the personal line at 15%.
4. Ask for a reduced interest rate.
Call all the companies and ask for a reduced interest rate. The worst they can say is no, right?
5. Check your credit report.
A few days after the end of the billing cycle for card #3, order your credit report to be sure that all the cards have the utilization updated. You should see a bump up in your credit score too.
6. Use a 0% balance transfer.
Here’s where adjusting the utilization and checking your credit report will pay off. Use the list of 0% Balance Transfer Credit Card Offers to identify 2 or 3 cards with different companies. Apply for the cards (on the same day). Once you are approved, transfer the highest interest rate balances to the 0% card in this order: (1) Credit card #3, (2) Personal Line, (3) Credit card #1, (4) credit card #2.
Be sure to check the terms and watch for maximum balance transfer fees. You may be able to have the balance transfers deposited into you checking, where you can avoid multiple fees.
7. Evaluate stocks separately.
Determine what percentage of your portfolio the company stock makes up. If it’s significant, you may want to sell. You can then decide if you’d like to use it to pay off debt. It’s important to keep a balanced asset allocation with or without debt.
Be sure you know the impact that taxes will have on selling the stock and set aside the appropriate amount to cover and capital gains taxes.
8. Aggressively pay off the debt.
Because he has a goal to be debt free in November, I would pay the cards down as fast as possible. I’m just guessing here, but I’m thinking that purchasing a house may be in the plans for November. It will be best to be free of all credit card debt before then.
At this point, hopefully all the balances will be at 0%. If not, continue to pay the highest interest rate. Once you have all 0% balances remaining, pay off those with the smallest balance first to get the “emotional high” of eliminating debt.
9. Avoid future debt.
Once all the cards are paid off, continue setting aside some of the money you were using to pay down debt into an emergency fund.
10. Earn rewards.
He mentioned that credit card #3 is a JetBlue Card from American Express that he’d like to use to earn free travel. Use the card for necessities, and be sure to pay off all charges every month.
For another idea and some number crunching comparing two payoff options, check out what Steward would do in this situation at My Family’s Money.
How about paying down credit card #2 and transfering credit card #3’s balance over to it? Bring down those rates…
Good ideas. I’d pay off #3 to get rid of the interest and free up some monthly cash to make payments on the others. Next would be that “personal line.”
Unless he plans to actually need his credit score to be good for some additional debt, I wouldn’t worry about the score until later.
I would certainly sell company stock to pay off 15% and 18% cards immediately unless there is some restriction on stock sale. It is extremely unlikely that the stock will grow at 15 or 18% a year. What he is doing by keeping stock and paying the credit cards is gambling that stock will grow at a higher rate. The probability of it is very low in the current market.
One correction. Depending on his tax bracket and whether he has short term or long term gains, the stock may have to grow at over 20% rate to grow faster than his debt. Stock gains are taxable, his interest is not.
If he has a loss instead of a gain, he gets to take it off his taxes. Then he can use his tax refund to pay off more debt.
Good plan. Personally, I would follow your advice #1, pay the minimum each month then apply for 0% balance transfers, ideally avoiding multiple transaction fees. After that, he should be uber aggressive in paying it all off.
Sounds good, though I wouldn’t bother with the o% cards since he’s got such a short timeline. Also, the dings from the new cards won’t help the mortgage he might be trying to get in the fall….
Thanks everyone for your thoughts. Hopefully I can get him to give us an update on how he is doing in a couple months!
I know I’m coming late to the dance, but I think most of you are overthinking the problem. He has (had, I hope)enough in stock and free cash flow to be free of all his revolving debt in a little over three months. I bet if he took a careful look at his spending, too, he could do it quicker. And shuffling around from one card to the other is, for most people, just asking for more credit card trouble. Over such a short period of time, interest rate has such little impact. Pay if off already!
I’m a little late to the ball game. Playing with credit is why this country is in its current financial situation.
In regards to his debt, cash the stock out and payoff debts 2 & 3 immediately. Then pay the minimum on the line of credit and attack card 1. Chipping away at debt is a lot like losing weight…without the quick gains and successes most fall off the track.
Cut the cards up…cash is king!