I have also given real life examples of how I respond to the Account Hierarchy as I track my portfolio and net worth each month.
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.
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.
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.
So, that’s how I would handle credit card debt in that situation.
How about you all? Would you have acted differently in the scenario above?
Do you prioritize your savings/spending in a similar order as this? Let me know!
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Related articles about credit card debt at several of my favorite personal finance blogs:
The Digerati Life – A Success Story About Paying Off Credit Card Debt
Blogging Away Debt – How I Reduced My Credit Card Interest Rates