However, one thing I have not done is explain a scenario of how I would adjust my action steps with money if I did have credit card debt. As such, this will be the topic of today’s post.
To start off, let’s just get an idea of where credit card debt falls on the
Account Hierarchy. Looking at the link, paying off credit card debt falls as the 3rd highest priority, only trumped by paying for health insurance and ensuring that you have an adequate emergency fund.
What’s the big deal? What makes credit card debt so bad?
A recent guest post (A Credit Card Debt Saga – And How I Survived) described in bloody detail what contributes to making credit card debt the worst debt we can have.
However, the long and the short of it is that this type of debt is bad because 1) credit cards carry high interest rates and 2) the interest is compounded daily.
How I would handle credit card debt
Now that we’ve gotten through the introduction of the topic, I wanted to walk through an example of how I would handle tackling credit card debt, if I was unfortunate enough to have accumulated it.
Assumptions
According to CreditCards.com, the average household credit card debt is ~$16,000. Wow!!!! This is incredible.
We’ll assume that this is the amount of credit card debt that I racked up with some emergency medical treatment I received while being airlifted off of the back country slope of a skiing mountain in Colorado (not covered under insurance). We’ll assume that I was completely free of credit card debt before this happened.
Additionally, we’ll also assume that I make an income of $50,000 per year ($4,200 per month) and do not pay taxes, for simplicity.
Action Steps
As you might have guessed, to tackle paying off this balance, I would start with the highest priority in the Account Hierarchy and work my way down from there.
- Priority #1 – Make sure that I have health insurance.
- Check – I currently have health insurance through my employer-sponsored PPO plan. Move to next priority.
- Priority #2 – Ensure that I have an emergency fund of sufficient amount to cover my expenses.
- Check. Move to next priority.
- Priority #3 – Pay off credit card debt.
- Ok – I know I need to pay this off. So, let’s skip this one and come back to it for now.
- Priority #4 – Pay off monthly mortgage payment.
- Check. Move to next priority.
- Priorities # 5-9 – Involve investing in your employer’s 401K, an Individual Retirement Account, and an individual taxable mutual fund account (in that priority order).
- Before getting hurt in the skiing accident, I was contributing 25% of my monthly salary ($1,041) to max out my 401K.
- On top of that, I was contributing another 27% of my monthly salary ($1,134) to a Roth IRA and taxable mutual fund account.
By looking at this, if I maintain my current savings pattern, I will be in direct violation of the Account Hierarchy because I will be saving for retirement and long term needs instead of paying off my high interest credit card debt.
To remedy this, I would stop, that’s right – STOP, contributing any money to my 401k, IRA, and taxable mutual fund account. This would free up $2,200 per month that I can put towards paying off my credit card debt. Of course, I would have to continue paying my mortgage payment, seeing as I need to have a place to live.
In addition, I would also look in to taking out a home equity loan (usually have lower interest rates, and the interest is tax deductible) to pay off the credit card debt.
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