Creit card repayment question
May 13, 2011 3:00 PM   Subscribe

Credit card repayment question.... I'm helping a friend put together a credit card repayment plan/strategy and i want to double check that my common sense is right. Assuming 3 cards with similar balances and different APRs, (and we'll assume that those won't change significantly though I know they might), and a fixed amount available to pay each month. I think it makes sense to pay as much as possible to the card with the highest APR until it it's fully re-payed before moving on to the next highest APR, all the while paying the minimum payments on the other cards to avoid fees....

My idea here is to minimize the amount of interest accrued to accelerate repayment.

The math makes sense to me, but I could be missing something... Am I? For example, how does this kind of behavior look to credit rating people?
posted by garethspor to Work & Money (17 answers total) 4 users marked this as a favorite
 
Credit ratings aren't based on which cards you pay off first, they are based on if you make your payments on time and how much credit debt you have (there's alot more to it than that, but that is the basis.

Dave ramsay calls this the debt snowball plan.

If your friend is savvy, he/she could go online and look for a 0% interest card (or low interest rate card) for a fixed period of time (usually 12 to 18 months) for balance transfers. There is usually a fee associated with this so you would have to do some math to figure out if it is worth it. Transfer all of the debts onto this account, but you would have to pay it off in the time allotted or else your interest rate would go up.

We did this with my wife's debt a couple of years ago when you could get a 5% interest balance transfer for the life of the balance transfer and it was totally worth it as she had alot of debt with interest anywhere from 15 to 25% over 3 cards.
posted by TheBones at 3:06 PM on May 13, 2011


You're talking about a variation on the debt snowball plan, which is recommended by many financial experts. The strategy of focusing primarily on one debt at a time is very sound. Many of the experts recommend ordering them from smallest to largest balance so that you're paying off a bunch of small debts to get the psychological boost of some "wins" up front. However, since your debts are all similar in size, I think ordering them by interest rate makes sense so that you end up paying the least interest total. Good luck!
posted by decathecting at 3:07 PM on May 13, 2011


I think your recommendation is fine. But a lot of folks recommend the snowball method, generally because "[t]he primary benefit of the smallest-balance plan is the psychological benefit of seeing results sooner" rather than because it makes more sense from a dollars and cents standpoint. A big part of any debt repayment strategy is coming up with a plan that will prevent discouragement and keep the person actually making the payments.
posted by bcwinters at 3:07 PM on May 13, 2011


I am not a credit counselor or a financial advisor, but that's usually the best approach. I've seen some finance gurus say you should go after the lowest balance first so you can have one paid off sooner (which has a nice psychological effect to it); I think they call it the "snowball approach."

Also, one other thing to keep in mind is that the credit ratings bureaus tend to give you a lower rating if you are tapping out your credit. So, in some circumstances, it may be better for your friend (from a pure credit rating perspective) to pay down the card with a $10,000 limit, a $10,000 carried balance, and a 12% rate before the card with a $20,000 limit and a $10,000 balance and a 17% rate (provided that s/he's current on all the cards).

Again, I'm not a credit counselor or a financial advisor, so this is not credit or financial advice... Good luck!
posted by Admiral Haddock at 3:07 PM on May 13, 2011


Amazing that all four of us within one minute cite the snowball method.
posted by Admiral Haddock at 3:08 PM on May 13, 2011


Suze Orman recommends this method, where you start with the highest-interest rate balance

This is actually the opposite of Ramsey's Snowball Method, which recommends that you start with the lowest balance first.

The benefit of Orman's method is that it is the cheapest way to pay off your debt in the long term. The benefit of the Snowball method is that you will free up some monthly debt payments faster, and if there's some kind of emergency that money could be diverted away from paying off credit cards.
posted by muddgirl at 3:26 PM on May 13, 2011 [1 favorite]


Not sure where your friend lives, but contrary to some of Admiral Haddock's advice, in Canada when applying for loans your credit cards are treated as if they are maxed out. Whatever your limit is, is what they put it down as on the liability side of things.

If the friend is in enough of a position to be needing help pulling together a repayment plan, I would tell said friend to pay off and close the card with the highest credit limit first. That will help their net worth statement the most. The 0 or low-percent balance transfer is an excellent place to start.
posted by pink candy floss at 3:28 PM on May 13, 2011


For example, how does this kind of behavior look to credit rating people?

Someone who is holding on to a lot of debt isn't in a position to worry about their credit rating. Their debt-to-income ratio is much more important.
posted by muddgirl at 3:29 PM on May 13, 2011


Someone who has accumulated a lot of credit card debt without worrying about interest rates is, by definition, not someone who is interested in the cheapest way of doing things. Therefore what method is financially the best is not the issue. The best payment plan is one you can stick to, period.

That is why Ramsay and others, including Michelle Singletary of the Washington Post, recommend the smallest debt first, and automatic payments if at all possible.
posted by wnissen at 3:30 PM on May 13, 2011


Response by poster: Thanks for the insight folks, This is helpful.
posted by garethspor at 3:40 PM on May 13, 2011


You'd actually have to run the numbers to see which is more beneficial.

In the good (bad?) old days, the minimum payment was very low, possibly even less than the interest accrued during that month. In that case, paying off the one with the highest rate makes sense.

But today, the minimum payments are higher, and you are paying all of the interest plus some percentage of the balance every month. In this case, it might be beneficial to reduce the number of accounts with balances in order to more quickly have the cash flow to pay off the big APR one. Not sure if it works out that way for real, that's why running the numbers is needed.

(On the other hand, the difference between the APRs is probably not that large, so it probably doesn't make a LOT of difference either way. So whatever feels best is best.)
posted by gjc at 4:09 PM on May 13, 2011


The best payment plan is one you can stick to, period.

This is one of the reasons I worry about the Snowball method for some borrowers - some people, when they pay off one debt quickly, may be tempted to pad out their budget rather than roll that extra amount into the next debt. If the first debt isn't paid off for awhile, they might be more used to their discretionary budget. Every person is different and has different motivations.
posted by muddgirl at 4:15 PM on May 13, 2011


In general, 0ne word: Yes.
All the other tactics are fine -- find a lower interest card, zero percent, etc. But always, always, pay your high-interest balances down first. You don't need Suze Orman to tell you that.
posted by LonnieK at 5:29 PM on May 13, 2011 [1 favorite]


I use a variation of the snowball method. I have three cards I'm carrying a balance on:

-A Citibank MasterCard (current balance of $900; this was a 0% balance transfer)
-A Capital One Visa (current balance of $1400; also a balance transfer--not 0%, but a much lower interest rate than the card I transferred the balance off of)
-A Discover card (current balance of $3000)

The MasterCard has an interest rate of 0% until August of next year, and the Capital One card has an interest rate of 5.99% until...I can't remember when exactly, but it was 18 months from a few months back.

Right now, I'm reducing the balance on each of those cards by $100 from the previous month's balance (for example, at the end of last month, the Citibank card's balance was $1000, and at the end of this month it'll be the aforementioned $900), and paying whatever else I can towards the Discover card, which has worked out to about $400 a month so far.

It may be needlessly complex, I don't know, but it's worked for me. I've gone from over $8000 in credit card debt at the beginning of the year to $5300 as of this posting, and I'm on track to have them all paid off by January.

Best of luck to your friend!
posted by andrewcilento at 7:42 PM on May 13, 2011


Does your friend have good enough credit to be eligible for a personal loan from a bank? Discover gave me a loan at a really, really reasonable fixed interest rate. Drawing it out gave me payments I could make reasonably. Three years later, I'm in the home stretch. And I sure as hell have been careful to not rack up any more debt.

I felt pretty sheepish at the time, like it was some sort of personal failure to take out a loan for credit card bills. But I could no longer convince myself to attempt the "transfer to the shiny new intro rate card and pay it off" maneuver AGAIN.
posted by desuetude at 7:52 PM on May 13, 2011


Seconding desuetude's suggestion of a loan. It works best if you can get a loan (from whatever source) that will pay off all (or most) your credit card balances all at once. Try to get a loan whose interest rate is less than your credit cards, and the smaller the better. Then stretch the loan payments out far enough (3 years? 5?) that you can easily make the payments each month on your monthly income. Finally, commit yourself to absolutely making the loan payment each month. The advantage, of course, is that when you're paying less in interest, more of your payments go toward reducing the loan balance.
posted by exphysicist345 at 10:11 PM on May 13, 2011


The loan idea is a sound one, especially if you can qualify for a low-interest loan from a credit union. I got a loan at 4.5% interest in 2007 to pay off some credit card debts in full, then paid off the credit union loan by late 2008 (it was a 3 year loan but the savings in interest charges on the credit card debt allowed me to pay it off early), and since then I've used credit cards very sparingly.
posted by motown missile at 3:22 AM on May 14, 2011


« Older Seeking Interesting Military Stories   |   Help me make the most of my solo retreat! Newer »
This thread is closed to new comments.