122 million Americans have credit card debt. The average debt per household is $8,448. According to the Federal Reserve, the average credit card interest rate is 14%, which means a family in debt could end up spending more than $1,000 every year on credit card interest alone.
But why do people remain trapped in credit card debt? Becoming debt free requires three key ingredients:
- A written budget that ensures you live within your means. Without a budget, your situation will only get worse if you continue to spend more than you earn.
- A debt payoff plan with a target date to become debt-free. Studies have consistently shown that good intentions are not enough to become debt-free. Decide whether you use the avalanche or snowball method – and stick to it. Your debt-free date should be a clear and obvious target.
- A plan to celebrate success. Intense austerity works – but only briefly. You need to find ways to reward yourself along the way as you achieve your milestones, otherwise you are likely to burn out and quit early.
If you do these three things, you will have a much better chance of eliminating your credit card debt. Unfortunately, people regularly make mistakes that keep them trapped in debt. Here are five of the most common:
1. You do not know why your budget doesn’t balance.
When creating a budget, it is easy to look forward and imagine how much you will spend. However, the best budgets are made by looking backwards – and understanding where your money (every last penny) went.
If you spend more money than you earn every month, find out why. What expenses are really driving it? And start with your big, fixed expenses. Far too many people sign up for a mortgage or car payment that just isn’t affordable. If you are spending 60% of your monthly take-home pay on your mortgage payment alone, balancing your budget will be challenging so long as you remain in your home or don’t find additional income.
If you don’t understand – in detail – where every last penny went, you won’t be able to create a plan that shifts the tide.
2. You are afraid to take difficult decisions.
Sometimes the right decisions are easy to calculate but difficult to execute. For example, you might have a car payment that is just too high. Mathematically, the decision is obvious: sell your car and buy a cheaper one. But emotionally, you just can’t imagine driving to work in an older used car.
Unfortunately, the reality of math ultimately wins. If you are unable to afford your current expenses, you will need to either reduce your expenses, increase your earnings or both. The longer you wait to make the tough decisions, the worse the problem becomes. Denial only becomes more expensive with time.
3. You don’t take advantage of automation.
It has become increasingly easy to automate good behavior. You can automate retirement savings, by enrolling in a 401(k) program. You can automate credit card payments. If you have a plan to become debt-free, you can make sure that the only money remaining in your checking account each month is your budgeted spending money.
Data shows that automation is the best way to achieve your financial goals. Humans are inherently lazy, especially when it comes to personal finance. If you automate good decisions, you will not need to deal with temptation on a monthly basis.
4. You convince yourself that “the points are worth it”
Make no mistake: earning miles and cash back can be a great way to put extra money in your pocket or a free flight on your calendar. However, those flights aren’t free if you end up deep in credit card debt. Rewards credit cards are fantastic if you pay your balance in full and on time every month. The math still works if you only revolve on your credit card occasionally. But if you are deep in debt, it is probably time to leave the credit cards at home and stop pretending that the free flights are worth it. Switch to a cash diet, and only get on a plane if you have saved enough money for the air fare.
5. You try to borrow your way out of debt
Debt consolidation loans and balance transfers can help you reduce the cost of your debt. When used properly, these tools can help get you out of debt faster – and help you save a lot of money. However, if you haven’t dealt with your spending problems, these tools can be dangerous. When you complete a balance transfer, your minimum monthly payment will reduce during the promotional period. If you have self-discipline and put as much money towards your balance during the 0% period as possible, you are being smart. But if you just keep spending and enjoy the lower payment, you could end up in even more debt at the end of the balance transfer period than when you began.