Transitioning from Credit Cards to Cash

Geoff writes in:

I was wondering if you could do a future post on transitioning from using credit cards to an all cash system. It seems like you would need some upfront cash for the transition. I think this would be helpful to a lot of readers.

I view the transition that Geoff is talking about – getting out of the routine of using credit cards to finance most of your spending and moving to a routine of using cash or debit cards to finance most of your spending – is a major first step toward getting your financial house in order.

Quite a lot of people – and this included myself, once upon a time – only manage their month-to-month finances thanks to their credit card. Their paycheck goes to cover a handful of bills and to make a payment on their credit card, then the rest of their expenses go onto that credit card. They never really pay down their cards and, in fact, their balances are usually drifting upwards over time.

Once you start to realize how much money you’re just handing to the credit cards each month and you realize how fragile this position is if you were to lose your job or something else, you want to get out of this situation quickly. I know that I certainly did.

One big step is to simply move from a situation where your credit card simply pays for everything to a situation where cash pays for everything and your credit card is just another bill.

This can be done slowly or it can be done quickly. The speed of the change mostly depends on how much of a lifestyle shock you can deal with in the short term. If you can handle a few months of extremely frugal living, then you can do it quickly. If you cannot… this transition will take a while.

The first thing you need to do is get a grip on your actual spending. Often, when people rely on plastic for their purchases, they have little true sense of where their money is going each month.

Sit down with your credit card statement and go through it very carefully. Do the same with your checking account statement.

Figure out what each item on that bill relates to. I suggest breaking things down into a handful of categories – eating out, food, entertainment/hobbies, household items, and so on. One easy way to do it is to get several colored highlighters and assign a color to each type of expense, highlighting your bill as you go through it.

Then, total up each type of expense. This will quickly show you what you spend on each category… and it will probably shock you. I know that I was utterly shocked the first time I did this.

The next step is to assign yourself a spending cap for your worst category. If you are way overdoing it on entertainment spending, give yourself a cap of, say, 50% of that for the coming month. So, if you spent $1,500 on entertainment expenses last month, cut that to $750 for the next month.

For just that category, spend only cash. Do not use your credit card for it. In fact, I find it useful to withdraw the total amount at the start of the month and keep it in an envelope somewhere.

In other words, move your most challenging spending to a cash-only system first.

Ideally, this should leave you with more room to breathe at the end of the month. Use that extra money to move more spending categories to a cash-only system next month. Set a spending target for that category that either matches or is a bit lower than what you know you’ve spent in a month on that category, then ban yourself from using plastic to pay for those expenses.

Essentially, you’re gradually moving into a simple budget while transitioning away from building up more credit card debt.

Once all of your categories are moved over, you should be spending well within your means. This is the point where you should be treating your credit card as a bill – one that you should be making extra payments on so that you can eliminate it as quickly as possible.

This whole process means you might need to live a bit leaner for a while, but, in reality, that just means being a little more selective and thoughtful about what you spend your money on. Focusing on one or two categories at a time helps you to really see how often you spend money in a non-productive way and when you see that your life quality doesn’t go down because you cut out that spending, you’ll wonder why you ever spent like that in the first place.

Eventually, a credit card can be a successful tool if you pay off the balance in full each month. If you’re not at a point where you can easily do that, a cash-only system is best.

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