Paying Off Credit Card Loans

Conventional wisdom suggests that paying off high-interest credit cards should be your number one priority before putting any money away for the future in savings accounts, retirement savings plans at work, or anywhere else. The reasoning for this guideline is financially sound. Why put money into an account that will probably earn less than 10% when you're paying interest on a credit card that's approaching 20%? Financially sound advice, for sure, but I often encourage a somewhat different and controversial approach to the pay-off-the-credit-card vs. save dilemma: do some of both.

First, there is a no joy forthcoming from making payments against outstanding credit card loans, a department store cards, gas company cards, etc. It's usually a monthly reminder of past spending sprees. Depending on the extent of the indebtedness, you might be looking forward to years of paying down the loans without making much if any progress toward a brighter financial future. On the other hand, putting some money, even a little bit of money, away for the future is always good for the soul, particularly for those souls who have little or nothing in the way of savings. So here's my strategy for paying off your credit cards later, rather than sooner.

  1. Figure out how much you can set aside each month to pay down credit card and other loans. Don't be overly ambitious in setting a target. It's better to come up with an amount that you know you can comfortably afford rather than setting a target that will be discouragingly difficult to achieve.
  2. Depending on how much you owe on the cards, plan to put 50% to 75% of your monthly "set aside" against the loans. The more debt you have, the more you should be putting toward reducing the loans. One thing you want to avoid like the plague is simply making the minimum required payments each month. If you just pay the minimum, you'll probably be in a nursing home before you pay off the cards. By the way, I hope I don't need to remind you that you should make only minimum use of these cards, lest you continue adding to the outstanding balances.
  3. Here's the fun part. Your "extra money" should be first be put into a savings account at your bank or credit union in order to build up a small cushion for any financial emergency that might arise. At a minimum, this cushion should be enough to pay a couple of months' worth of card payments in the event you run short at some point in the future.
  4. Here's the even more fun part. Once you have enough money in your savings account, you should then put your extra money into a retirement savings plan. If one is available at work, by all means participate in that so that you can enjoy some tax savings and possibly a match from your employer. Absent a workplace plan, you can always start making monthly contributions to an IRA account.
  5. If you are blessed with more abundant resources in the future, for example a raise or bonus at work or cash gifts from relatives, don't use this happy event as an excuse to increase your spending commensurate with the increase in income. Instead, put one third toward your credit cards, one third into retirement savings, and enjoy the remaining third.