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By Thomas Muellner
Shedding the weight of long-term credit card debt can be an amazing triumph. For many, it comes after years of struggling to make monthly payments and balance shoestring budgets in the hope of financial freedom.
But once you’ve paid off your last credit card bill and the slate is clean, you may be wondering what to do next. Should you chop up your credit cards and close your accounts (hint: no)? Fund a new investment? Pay off other types of debt?
While there’s no one-size-fits-all answer, some options may align to your financial goals better than others. So, give yourself a much-deserved pat on the back for taking control of your credit card debt, and then use these tips to put yourself on the path to long-term financial wellness.
Like any bad habit, the temptation to slip back into a pattern of irresponsible spending can tear down months of hard work erasing debt. Because of this, it’s important to maintain the same level of discipline and financial awareness that you had while paying down your debts while getting used to your new financial freedom. Though you’ll no longer have a credit card payment each month, you can create new goals and use the money that would have gone toward debt and interest to build up your own portfolio.
This is a great time to set up an emergency fund if you don’t already have one – or to beef up one you already have. By setting aside three to six months of living expenses in a simple savings account, you can rest easy knowing that you won’t need to turn to plastic if you fall on tough times.
At the same time, take pride in knowing that you’re part of a unique minority. On average, consumers between the ages of 18 and 65 hold nearly $5,000 in credit card debt, and only about one-third pays off their balance in full each month. By striving to live without carrying any credit card debt, you’re already ahead of the game.
While you may want to shred your credit cards to pieces once that final bill is paid, it’s in your best interest to resist that urge. One of the key factors in determining your credit score is the age of your current accounts, so by keeping lines of credit – but not too many – open and active you’re continuously improving your position with lenders. What’s more, by closing a credit card account you’re decreasing the total amount of credit available to you which is another potential red flag to lenders and can ding your credit score.
Instead, decide on a few specific purchases (e.g., a Netflix subscription, groceries, etc.) you feel comfortable making with credit and budget them the same as if you were paying from your checking account. At the end of your billing period, pay the card off in full and move on to the next month with a zero balance. You may even want to pay your bill online or with a smartphone app as soon as each transaction posts when you’re first getting started.
But also beware. As your credit score increases, you will start to receive offers for additional lines of credit and new rewards credit cards. These can provide awesome incentives to savvy spenders who use credit responsibly. As someone who has carried credit card debt in the past, however, you need to be careful that the rewards don’t tempt you to spend frivolously so you end up back in long-term debt. If you’re not paying off the balance in full each month, the accrued interest will quickly wipe away any cash-back or travel rewards you might earn.
As you’re transitioning from a budget constrained by credit card debt to one that affords you the flexibility to save, take time to review your other debts. Though student loan debt, mortgages and car payments all factor in determining your financial health, deciding which debt to attack next (if any) may not be a black and white decision. You may find that it’s actually better to start saving for retirement or investing in other opportunities to maximize compound interest earnings, especially if your remaining debts are at low interest rates.
For example, if you have $12,000 in student loan debt at a fixed 5 percent interest rate, you may be comfortable making only your scheduled payments and putting surplus funds toward savings. Conversely, if you’re paying down a $12,000 subprime car loan – set at an 11 percent interest rate due to your past credit issues – it may be wise to start making additional payments on that high-interest loan.
Once you’ve re-assessed your other debts and set aside cash for an emergency fund, a great next step is to double down on retirement savings. Using the cash you would have dropped on credit card payments, increase the contribution to your employee-sponsored 401(k) plan or IRA account. Saving 10 to 15 percent of your income is a good target to set; however, every extra dollar makes a difference. Most individuals can put away up to $18,000 in 401(k) accounts and up to $5,500 in IRA accounts each year.
That said, planning for the future can (and should) include both long-term and short-term financial goals. It doesn’t have to be one or the other, and you can save for multiple things at one time.
So, as you’re building your nest egg, don’t forget to set your sights on smaller savings objectives. Whether it’s a new pair of shoes, a remodeled kitchen or a trip to Europe, pay yourself back with things that make you happy and celebrate your financial diligence – you’ve earned it!