If you’re struggling to pay off credit card debt and aren’t sure which way to turn, you’ve come to the right place. We’ll show you how basic budgeting and saving skills can help you set aside the cash you need to tackle your debt, then build a foundation of savings to help prevent you from going into the red again.
Step 1: Review your take-home pay
Not knowing your monthly take-home pay makes it difficult to know what you have to work with as you try to make and keep a budget. Employers usually list your take-home pay as “net pay” — that’s what ends up in your pocket each pay period. If you receive a salary or work the same number of hours every week, that amount likely won’t fluctuate much. But if your income is irregular, you can average your last 3 to 6 months’ worth of income to come up with a monthly figure to work with.
Keep in mind that if you get a tax refund every year, it’s likely because your withholding is too high. You can use the IRS withholding calculator to find out if this is the case. If so, consider changing your withholding with your employer by filling out a new W-4 form. While it will result in a lower tax refund, your take-home pay will increase. Keep in mind that by withholding too much you are giving the government an interest-free loan rather than using that cash to pay down your debt and cut your interest costs.
» MORE: How to pay off debt
Step 2: Create a budget
Understanding your expenses and keeping a monthly budget is essential if you’re trying to pay off debt, says financial advisor Patricia Jennerjohn, CFP®, MBA in an email interview with NerdWallet. Your budget will give you an idea of where your money is going and how you can change your spending habits to make room for extra debt payments and savings:
List your monthly expenses. Start with areas where you usually pay a fixed amount every month, such as rent or mortgage, phone, internet and loan payments. Then record your variable expenses such as entertainment, shopping, groceries and eating out. You generally have more control over these and can make adjustments, if needed.
Budget each spending category. It’s important to “focus your energy on reducing expenses that you can control, e.g., your cable bill, entertainment or eating out,” Jennerjohn says. Setting a limit for yourself in these categories will help you make more cash available for important goals like paying off debt and saving. Resist the urge to budget all your income, however. It’s best to leave a buffer in case something unexpected happens.
Track your purchases. A budget doesn’t serve you well if you “set it and forget it.” After establishing your spending goals, be accountable to yourself by keeping track of your everyday expenses. At the end of the month, evaluate where you did well and where you can improve the following month. This process takes time, but it can help you set yourself up for success in the long run by creating opportunities to pay off credit card debt more quickly and save for the future.
Step 3: Direct unspent dollars to debt payoff
Once you have your budget in place and you’re saving money that you would have otherwise spent, start putting that cash to good use:
Set a goal. Jennerjohn recommends setting aside a fixed amount that you can devote to debt reduction every month. “This should be the sum total of all of your minimum payments, plus an additional amount,” she says. This is usually a better course of action than simply using the excess at the end of the month because you might be tempted to spend the money on something else.
Attack high interest rates first. It may feel good to pay off your lowest balance first, but you’ll save more in interest if you put your extra dollars toward the credit card with the highest interest rate. Once you’ve paid it off, direct your focus to the card with the next-highest rate. Keep doing this until your debt is completely gone.
Don’t panic. If you find that you don’t have any leftover dollars, don’t give up hope. Strive to increase your income, or go back to step 2 and take a second look at where you can make cuts to your budget.
Step 4: Start saving
After you pay off your credit card debt, it may be tempting to spend all that extra cash every month. But if you want to avoid going into debt again in the future, it’s time to save.
Establish an emergency fund. Paying off your credit card debt is great, but it’s also important to start saving so you can avoid going into debt again. Calculate your average monthly household expenses and put aside enough each month to save at least 6 months’ worth.
If you don’t have any savings before you start paying off your credit card debt, consider splitting your unused cash between debt and savings until you have at least a month’s worth of expenses in the bank.
Establish mid- and long-term savings goals. While you’re saving for the unexpected, look ahead to other savings goals you might have. For example, you may want some cash in a few years for a down payment on a house, a family trip or a new boat. When the time comes, you’ll be glad you saved enough to be able to avoid using credit.
Keep your eyes on the prize
Paying off debt and saving for the future take time. It can be hard to keep your eye on a prize that doesn’t provide an immediate return. Therefore, it’s important to remind yourself regularly why these goals are important to you.
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