The Simple Way to Decide Which Credit Card to Pay Off First
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Owe thousands of dollars in credit card debt? You're not alone. As of late 2015, U.S. households with credit card debt owed an average of $15,355 on their plastic, according to a study by NerdWallet.
Unfortunately, credit card debt is the worst kind of debt to hold because it comes with such high interest rates. CreditCards.com reported as of early March that the average credit card in the United States came with an interest rate of 15.16%. Such a high rate means that credit card debt grows quickly, especially when that debt is large.
Dealing with credit card debt can be overwhelming. But there are strategies you can take to whittle that debt down to manageable levels. The key is to start paying off your credit cards in full one at a time.
That leads to the big question: Which credit card should you pay off first? There are two approaches you can take to answer this question.
Snowball Method
In what is known as the snowball method of paying off your debt, each month you pay the minimum required monthly payment on all of your credit cards except one — the card with the lowest balance. You use the majority of your available money each month to pay off as much of this card's balance as possible.
Then, when you pay off the debt on that card, you repeat the process: You pick the card with the next-lowest balance and use all of your extra money each month to pay that balance down, making just the minimum required monthly payment on the rest of your cards.
You repeat this process until you've paid off all of your credit card debt.
Fans of this approach like the feeling of accomplishment it brings. It's a good feeling to pay off that first, second, and third credit card. And by targeting cards with the lowest balances first, you reach that good feeling faster, meaning that you'll be less likely to get discouraged and give up your efforts at reducing your debt.
Avalanche Method
The avalanche method is similar to the snowball approach, but with one key difference. Again, you make the minimum payments each month on all of your cards except for one. But in this method, you devote all of your extra funds to paying off the balance of your credit card with the highest interest rate first. (See also: Snowballs or Avalanches: Which Debt Reduction Strategy Is Best?)
After you pay off that card, you move on to the card with the next highest interest rate, working your way down your credit cards until you've paid them all off.
Supporters of this method say that it makes the most financial sense. You'll end up paying less if you eliminate your debts with the highest interest rates first.
On the downside, though, your card with the highest interest rate might also be the card that you owe the most on. This means that it will take longer for you to enjoy the satisfaction of paying off a card completely.
Either method, though, will work, if you stick to it. So choose the approach that works best for you.
Pay Less Interest With a Balance Transfer
Once you have determined your course of action and have a good idea of the time frame you are working with, you can save money and buy some interest free time by doing a balance transfer to a credit card that offers a 0% APR on balance transfers. Make sure that you can pay off that balance in full within the promotional period, or else you'll just get hit with interest fees again.
For example, if you know you can pay off $5,000 in a year, instead of paying interest on that amount while you are paying it off, transfer $5,000 to a new credit card with a balance transfer offer. Make payments towards the new card instead of the card you were going to put it on. If your current card has a 15% APR, you'd save hundreds in interest charges for that year.
Keep in mind that most cards that offer a promotional balance transfer period will charge a 3%-5% fee on the balance transferred. Most of the time this would still be cheaper than paying the interest on your current cards. There is one card though that offers a 0% intro APR for 15 months AND has no intro balance transfer fee if you make the transfer within 60 days of opening your account — Chase Slate Card. It's the best card for balance transfers. (See also: When Should You Pay Off Credit Card Debt With a Balance Transfer?)
When It's Paid, Don't Close It!
And here's one more tip: Once you do pay off a credit card, don't close that account. Doing so will hurt your FICO credit score. If you use less of your available credit, your score will be higher. But if you close a credit card account, you'll immediately raise what is known as your debt-utilization ratio — the amount of your debt you are actually using. This will cause your credit score to fall.
So keep those paid-off credit cards open. But resist the temptation to run up the debt on them again.
Have you paid-off credit card debt? What method did you use?
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Tagged: Credit Cards, Debt Management, avalanche method, closing cards, debt repayment, snowball method, strategies
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