One thing that constantly amazes me is the frequency with which people argue with my advice of avoiding credit cards altogether. Sometimes it is the argument of “rewards” offered or cash back on purchases. Sometimes it is the “I only use it for emergencies” claim or the “I don’t ever use it, but I keep it…just in case” discussion. No matter how they push back, I get an astounding amount of resistance when I tell someone to stay away from credit cards. So I thought I’d put forth my reasons for developing this opinion and open it up for some additional discussion or debate.

It is not uncommon for someone to passionately defend their use of the little 2-1/8” x 3-3/8” piece of plastic in their wallet and sing its praises on high. Why? I believe the credit card represents what is “normal” in America. A credit card represents buying power. A credit card can earn rewards/points with purchases. But here’s the catch: a credit card gives you the power to go buy something you can’t pay for. While everybody may have a credit card (or several), there are lots of things everybody else seems to be doing that may not be a good idea for you. Think about it. The average American lives paycheck to paycheck. The average American isn’t saving for retirement. The average American is DEEP in debt. None of those things sound like good things, but everybody is doing it. Let’s get into some of the specific issues I have with the use of a credit card:

1. You will spend more. There are lots of studies out there that show you’re not emotionally tied to spending when you swipe a piece of plastic. It doesn’t ‘hurt’ when the cashier gives you a total and you hand him a credit card. On the other hand, when you have to count out those greenbacks, your body recognizes this as a cost to you and it makes it harder to fork over those beautiful pieces of paper. Most research has concluded that you will spend 15% more on average if you use plastic than if you use cash.
2. You are assuming you can eventually pay for it. While things in life are usually perfectly fine, our recent economy has proven things don’t always go like you think they will. When you use your credit card, you’re making the assumption that you are going to be able to actually pay the bill. Since the average American lives paycheck to paycheck, this means you’re spending money you don’t have and thus are assuming you will have money to pay it when the bill arrives. This also assumes you will keep your job, that there won’t be an issue at the bank, and that something of greater importance won’t demand your financial attention first. Life happens and credit cards add an automatic element of risk to your situation.
3. Additional discipline is required to pay it off (monthly or over time). Assuming everything goes great and you don’t have a financial meltdown during the period between your credit card purchase and the date on which the bill arrives, you still have to keep in mind that bill is coming. When you use cash, you know the money is spent because you don’t have it anymore! When you use a credit card, you have to consider that the balance in your checking account or the money coming in next week’s paycheck is already spent and not over-extend your money. THIS HAPPENS ALL THE TIME.
4. “Rewards” are often expensive or never used. The most common set of arguments I get when talking with nerds like myself is the “I get airline miles” or “I get cash back on my purchases.” Let me be very clear when I say that there are promotional offers for credit cards that are very appealing and IF you take full advantage of them while still paying off your card every single month there is benefit to be had. BUT (and it is a huge BUT…ha ha) you must get it absolutely, perfectly right and have the extra discipline to play by their rules or you’ll get bitten.

I liken credit cards to a coiled up rattle snake. There are people everywhere that handle snakes with caution and never get bitten. Then there are others who are killed because they were either careless or the snake decided it didn’t want to behave. No matter why you believe having a credit card is a good idea, I don’t think you’ll convince me the merits outweigh the risks. I’ve been there; I’ve worked in the industry and know the rules change all the time. I’ve also consoled countless families who were “bitten” by their credit cards and it nearly killed them.

Today we’re going to tackle the fourth step in the process of overcoming your debt. Before we get into those details, let’s take a look at the five steps. In order, they are:

1. Cut Expenses
2. Maximize Income
3. Get Current on Everything
4. Use the Dave Ramsey Debt Snowball to Arrange Your Debts
5. Make a Call Every Time You’re Ready to Pay Something Off

Since we’ve already covered steps 1, 2 and 3 (Cutting Expenses, Maximizing Income and Getting Current on all your past due bills, respectively), today we’ll discuss step 4: the Debt Snowball.

I love Dave Ramsey. He is awesome. When Stacy and I paid off our mortgage (our very last debt), we drove to Nashville so we could scream “I’m Debt FREEEEEEEEEEEEEEEEEE” on the air from his studio. It was a wonderful experience and meeting him was quite cool. Most of my teachings line up with his and while there are many nuances where we differ, I can’t find any good reason to deviate from his plan on how to tackle your debts. So let’s go over what the debt snowball is and how it works.

Get Everything in Order

First, you need to know what your debts actually are. Find out ALL of your debts, what each requires as a minimum payment and the overall balance you owe. Ignore interest rates. Order those debts smallest to largest based on the overall balance. Pay minimum payments on all of your debts EXCEPT the one with the smallest balance. Put every extra penny you can scrape together toward paying off that smallest debt. When it is paid off, you can put the required minimum payment it had on your next smallest debt, as well as every penny you can scrape together toward killing that one. Simple, right?

The Why

Mathematically, this approach makes no sense. But as Dave says, this isn’t about math. If you knew the math, you wouldn’t have gotten into these messes in the first place. So we’re not worried about the interest rates or things like that. We’re looking strictly at paying off the debts – making them go away. When I teach, I put it this way: imagine yourself in a dark alley late at night. Out of the shadows steps ten scary goons. If I have the option to either make the biggest one smaller or make the smallest one go away, I’m going to choose that second option EVERY TIME. The debt snowball helps you get rid of the goons more quickly because you’re getting rid of the smallest one first (and most quickly), then the next smallest, etc. Eventually, you’re only battling one or two big goons. By that time, however, you’ve built up the momentum, discipline and drive to beat him/them, so you win!

So that’s it. Debt snowball your debts once you’ve cut your expenses, maximized your income and gotten current on all your debts. Then you’re ready to start knocking them out. Stay tuned for Step 5 because as you get ready to pay off a bill, we’ll talk about how to make a call and save some serious cash by investing 10 or 15 minutes of your time. I’m looking forward to it – I hope you are!

image by Brad_Chaffee

I know, I know…you’re wondering why there would be a “five-step” system that technically has six steps. Well, I don’t count this one because I hope you don’t have to deal with this one, even if you do have past due debt. Nonetheless, if you find yourself on step 3 with lots of collectors hounding you, I want you to be prepared and have some tools in your arsenal to deal with them. What qualifies me to discuss this? How about the six years I spent working as a debt collector and training debt collections for one of the world’s largest financial institutions? I’ve talked with literally thousands of people who are past due on their bills and heard just about every story out there causing those problems. So how do you deal with collections? Here are my five top tips:

1. Know your rights– Some of the most boring reading you will ever do (and the only chapter in my book that I feel I need to apologize for) is the chapter regarding debt collections and the law. There are four major laws you need to be familiar with as someone who may be dealing with creditors. They are:
   • Fair Debt Collection Practices Act (FDCPA)
   • Fair Credit Reporting Act (FCRA)
   • Fair and Accurate Credit Transactions Act (FACT Act or FACTA)
   • Credit Card Accountability Responsibility and Disclosure Act of 2009 (Credit CARD Act of 2009)

   Please allow me to make a shameless pitch for my book if for no other reason than I’ve taken these four federal laws and broken them down into what they really mean for you. If you know your rights then you know what is and isn’t allowed by a collector. For example: are you getting calls late at night? That’s a big no-no! FDCPA says collectors may call between 8a-9p in your time zone. Are you getting calls at work? FDCPA says that all you have to do is tell the collector you’re not allowed to receive calls at work and they have to stop calling you there. See how handy this information might be!?

2. Be reasonable/realistic – Since you are working with a limited amount of income and must prioritize how to spend that income, you must be reasonable when choosing who gets paid and who does not. If a collector is trying to “make an arrangement” with you and you don’t have the money, don’t set up the arrangement. Be reasonable with yourself and with the collector and be realistic in what you can/cannot do.
3. Be logical – A collector’s primary job is to get you to pay him/her before hanging up the phone. That means good collectors will use emotion to beat you at the numbers game. If you’ve followed my advice thus far and been reasonable and realistic in what you can pay, don’t let a collector change your plans by using emotion. If you get emotional (mad, sad, scared), you’ll do something desperate. Use logic, not emotion.
4. Choose your battles – If you’re emotionally spent, you are in no shape to be working with a collector. You will not do very well. My advice to those I counsel is to talk with a creditor once per week or when something changes. If you are ready to make a payment or if some major change occurs in your situation, talk with them. Otherwise, only answer their calls about once per week. Calmly advise them of what’s going on (if there’s anything new) and tell them your plan of talking with them once weekly or when something changes. They won’t like it, but it keeps you from spending hours on the phone fighting and draining yourself emotionally.
5. Know the difference between secured/unsecured debt – Sad to say, most Americans don’t know the difference in a secured debt and an unsecured debt. A secured debt is one that is backed by an asset (like your car or house). If you don’t pay, you lose that asset. Pretty much everybody knows that if you don’t pay your car payment, the car gets repossessed. That’s because it is a secured debt. An unsecured debt (credit cards are the best example here) is one that if you don’t pay, there’s really nothing the collector can take from you. Learn the difference in secured/unsecured debt because if a collector tells you you’re going to lose your house if you don’t pay your credit card bill, you can be assured that collector is a moron. Learning this difference will also help remove the fear of what happens if you aren’t able to pay for a long period of time – scary words like foreclosure, repossession, judgment, etc. become less fearful because you know what they all look like.