If your monthly to-do list includes dedicating a chunk of change to your credit card balance — or multiple balances — you’re not alone. Approximately 4 in 10 Americans carry revolving debt on their credit cards, according to a 2012 survey by the National Foundation for Credit Card Counseling and the Network Branded Prepaid Card Association. And although the average debt varies by source, credit reporting agency TransUnion puts the sum at $4,878, not including zero-balance cards and retail credit cards.
There are only so many ways to pay off a credit card if you have a significant amount of debt and an insignificant amount of money. But here are the three common strategies people in your situation employ, along with what you need to know about each option.
Focus on the card with the highest interest rate. Most financial experts say this is the way to go. Scott Halliwell, a certified financial planner at USAA, a financial services company that specializes in helping the military, speaks for many when he says: “The best move from a purely financial perspective is to attack the highest-interest rate cards first.”
It makes sense. The card with the highest interest rate is usually the one that will cause you the most financial pain. The national average interest rate on a credit card is 15.2 percent, so if you bought a $1,000 refrigerator with a credit card, you’d pay a lot in interest if you took your time paying it off. Most monthly payments are 4 percent to 5 percent of the balance, so if you’re making a $40 to $50 monthly payment, you can see how things can get bad in a hurry. Only making $40 monthly payments on that $1,000 refrigerator means you’ll pay it off in 65 months and shell out $368 in interest.
So focus on paying off that high-interest credit card while at least making the minimum payments on your other cards. Once you’ve accomplished that, Halliwell says, “roll all the money you were applying to [the highest-interest card] each month to the debt with the next-highest interest rate. And so goes the process until all the debt is eliminated.”
But beware: This is a responsible approach, but it can be a slow one. If you’re buried under a lot of revolving debt and living paycheck to paycheck, you may get overwhelmed by how slowly it’s taking to pay everything off. Then, like a dieter falling off the wagon, you may end up using your credit cards and adding even more revolving debt.
Aim for the card with the smallest balance. If you’re someone who likes to see progress, try what Zev Fried, a financial adviser with JSF Financial Services in Los Angeles, calls the “snowball” strategy.
It involves paying off the credit card with the smallest balance first while, of course, continuing to pay at least the minimum balance on your other credit cards. Once you’ve done that, take the extra money you now have every month and apply it to the credit card with the next-smallest balance. After that one’s finally paid off, you should have even more money to hurl at any other credit cards. Your extra money snowballs and eventually overpowers the debt on that last credit card.
“Generally, we recommend clients estimate the most expensive debt first since they will pay less interest,” Fried says. “However, the snowball method’s value is psychological and behavioral. It feels good to see an account at zero. This often motivates them to stick with the program and become debt-free.”
Passard Dean, an associate professor of accounting at Saint Leo University in Saint Leo, Florida, and a former employee at the credit reporting agency Equifax, also likes the snowball method. “While it may make more logical sense to attempt to pay off the card with the highest balance to save on total interest paid, we need to be cognizant of the fact that we like to accomplish short-term goals, and the card with the highest rate may not be the one with the lowest balance,” he says.
But beware: As Fried says, in the long run, you will probably pay more in interest.
Target somewhere in between. If you have $300 to throw at debt on four credit cards, and it makes you feel better to hurl equal amounts at each card, that’s fine if it keeps you on track — provided you’re making at least the minimum payment for the cards and preferably paying more than the finance charge. The finance charge is the fee that makes up the interest you accrue every month if your card isn’t paid off in full by the payment due date.
“It really does depend on how the person is wired and which method will keep them motivated until the finish line,” says Gail Cunningham, spokeswoman for the National Foundation for Credit Counseling.
But beware. Since you’re acting on emotion, and your strategy is more reliant on what feels right, make sure you’re paying your bills on time. That’s important no matter how you pay off your credit cards, because late fees will just make your debt fatter and possibly cause your interest to climb. Since this approach will probably be the slowest one, paying on time is even more vital.
Also, you need to look at that finance charge as much as you do the minimum payment, says Rakesh Gupta, a business professor at Adelphi University in Garden City, New York, who teaches a freshman seminar called “Your Money and Your Life.”
“Some credit cards’ minimum payments are less than the finance charge,” Gupta says. So if that’s the case, and you pay the minimum but the finance charge is higher, “you wind up paying interest on the interest,” he says.
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3 Strategies to Pay Off Your Credit Cards originally appeared on usnews.com
