Skip NavigationCatherine Falls Commercial | Moment | Getty Images
Credit card debt can happen for any number of reasons.
Some people get carried away swiping their cards on discretionary items like clothes and home goods or leisure activities like dining out or going to the movies. Other folks run into emergencies like a car repair or medical issue and don’t have the cash to cover it. And especially as prices for essentials like gas and groceries remain elevated, many Americans are relying on credit cards just to get by.
Regardless of how you got there, you need to be careful when facing a large debt balance or risk seeing it spiral out of control. Because credit cards typically carry high interest rates, your minimum monthly payment generally won’t touch much, if any, of the principal balance. A $5,000 balance with the average 23.79% interest rate, according to LendingTree, accrues nearly $100 in interest per month, meaning your payments would need to exceed that much to really bring your balance down. You’d have to pay at least $472 a month to have the debt paid off in a year, according to LendingTree’s payoff calculator, assuming you don’t add to the initial balance at all.
Now imagine you have an emergency come up while you’re working to bring down that balance. Without some cash funds set aside to cover it, you could find your monthly debt repayment costs growing beyond what you can feasibly afford to pay.
Paying off debt while also saving for emergencies can be a tricky balancing act, says Cassandra Rupp, a senior wealth advisor and certified financial planner at Vanguard. But it’s crucial to do a bit of both at the beginning of your journey to avoid a debt spiral.
“Unfortunately, debt tends to snowball…there just has to be a prioritization of, here’s what the [emergency cost] was, here’s how I’m going to to get that back and then … how am I saving that emergency bucket so that this doesn’t happen again,” she says.
Start with an emergency fund
You may be tempted to put every available dollar toward your credit card debt, but if you don’t have an emergency fund, Rupp says you should start there. Whether you recently wiped out your savings to cover an emergency or just haven’t prioritized building that fund, it’s important to give yourself a financial buffer so you don’t fall deeper into credit card debt or forego other financial goals to cover a large unexpected expense.
“The first thing I would always say is just making sure you have that emergency savings bucket,” she says.
She recommends aiming to stash away $2,000 or half a month of expenses — whichever is higher — to get started. Long-term, you should try to have three to six months’ worth of your living costs saved in case you find yourself out of a job or losing another income source, she says.
At the same time, Rupp says you should take advantage of “free money,” such as getting the full benefit of your employer’s 401(k) match, when available. If you’re able to do that while stacking your cash savings for emergencies, all the better.
If you have high-interest debt, avoid saving ‘too much’
Rupp recommends making at least the minimum payments on your debts while you work on other priorities, such as building your emergency fund and making commonsense contributions to your workplace retirement account. But don’t fall into the trap of saving too much cash, she says.
While it’s generally a good thing to grow your savings, you’re unlikely to earn more than a few percent in interest on idle cash. Meanwhile, your credit card balance may be growing at an annual rate of 20% or more. If you’ve been piling extra cash into savings, consider “repositioning those savings over to paying the debt, which would result in just overall better financial health,” Rupp says.
It’s a fairly common issue — a Vanguard survey recently found 57% of investors carrying credit card debt have the money to pay it off. Many are contributing to their 401(k)s beyond the amount their companies match or making extra payments on low-interest debts like mortgages, the investment firm found. But those strategies may be creating a “false sense of security,” Rupp says.
“It feels better to see this cash bucket increase and know that that’s at your fingertips versus putting it towards debt,” she says. “You may feel like you have more assets available to spend or to make the summer plans, and in reality, that really should have been going towards debt.”
Have a plan and automate it
Once you have a solid emergency fund, then you can put more focus on bringing down your debt balance. Your personal situation — the amount of debt you have and what the interest rate looks like — will help determine how much you should put toward the debt and how much you should continue putting in savings, says Rupp.
No matter how you divvy things up, Rupp recommends setting up automatic transfers so money is put toward your savings and credit card bills before you have the chance to spend it.
“When we’re at that point and there is a little excess, having some sort of automated plan to come into a high yield savings, even if that is a very small amount, [it’s] kind of out of sight, out of mind. It’s already scheduled. That makes things so much easier for investors,” she says.
Additionally, when you get cash windfalls like a bonus or tax refund, have a system in place to dedicate a portion of those funds to your savings or debt payoff. That said, Rupp doesn’t recommend counting on that money to cover major spending periods.
“I would always rather not pre-spend the money,” she says. “From an emotional perspective, it puts you in a bad place to know that something is coming and it’s already spent and leave yourself no flexibility there.”
To maximize flexibility, Rupp generally recommends planning for the unexpected, and to that end, it helps to know where you stand financially what what your priorities are.
“It takes a lot of stress off of your shoulders to to sit back and make a plan,” she says.
Want to get ahead at work? Then you need to learn how to make effective small talk. In CNBC’s new online course, How To Talk To People At Work, expert instructors share practical strategies to help you use everyday conversations to gain visibility, build meaningful relationships and accelerate your career growth. Sign up today!
VIDEO09:36I quit my $250K/year tech job–now I make $33K/year selling matchaMillennial Money
About The Author
