Will be debt Free in 3 years -- What order should i pay off my cards?

Question

I have budgeted to the point where i can close all credit cards i have in close to three years from now.

My question is, should I simply pay 1/3 to each card (will be over minimum payment on all)

OR

should i pay the most i can to one card and minimum to the remaining? Essentially taking out the cards one at a time.

Thanks!

Answer 1

I would pay the minimum on two cards and then pay as much as you can to the credit card with the highest interest rate. After taking out the highest interest credit card, I would then pay as much as possible to the card with the 2nd highest interest rate while paying the minimum on the 3rd card. This will give you the shortest pay-off period by taking out the highest interest rate first.

Example

• Card A = 20% interest rate and $5,000 balance
• Card B = 22% interest rate and $3,000 balance
• Card C = 12% interest rate and $2,000 balance

With the above example, I would pay as follows:

1. Pay the minimum monthly amount on cards A and C, while paying as much as possible on card B until the $3,000 balance is paid off.
2. Pay the minimum monthly amount on card C, while paying as much as possible on card A until the $5,000 balance is paid off.
3. Pay as much as possible on card C until the $2,000 balance is paid off.

Answer 2

Pick the order that is most exciting for you! They key to the process is to keep at it and you should use every trick you can find to make sure you stick with it. Three years can feel like a very long time.

The debt snowball, while not the mathematically maximized order, is set up to give you milestones along the way and give them to you early: the first debt you pay off is the smallest so you get that sense of accomplishment as soon as possible. And when you roll that old payment into the next, you see the larger debt disappearing faster (the snowball effect!).

Other folks get that satisfaction from maximizing their paydowns and focusing on the highest interest balance first, no matter how small of an advantage there is. If that is what keeps you working at it, do it.

Personally, my second mortgage is the one that bothers me the most, even though its not the smallest or the one with the highest interest rate. Its the one that gets under my skin and irritates me. Paying extra money towards that one just makes me feel good and I want to keep paying more!

You should still do the math to know how much more you are paying to make your choice; knowing that information may change your answer. If I had credit card debt at >22%, that would most certainly be where all my extra cash would go since I can't stand interest rates that high. My point is that you should pick what works for you given all the facts including understanding what motivates you and keeps you working towards your goal.

Get started and stick with it!

Answer 3

Paying off the highest rate card first is certainly not a myth, it's the fastest way to pay off one's debt. So, I agree with Matthew's answer above. Marcin - I would invite you to give a clear example where paying a lower rate debt results in a faster payoff.

The "debt snowball" (The concept of paying the lowest balance first to pay off in full and then move to the next) may very well be emotionally satisfying. But at a price. I wrote an article about the Dave Ramsey Debt Snowball, and linked to a spreadsheet that lets you compare the two methods. Keep in mind, for those who have a lot of debt on credit cards, their low rate cards typically have low limits, so having 5 cards with 8% rates but each with $1000 credit isn't unusual. Why pay those off when you have a $5000 balance on a 24% card? This difference adds up to thousands over a few years.

Answer 4

There are a couple strategies for this - one that Matthew proposes - which is mathematically the best - pay off the highest interest balances first and minimums on others.

The other is that you start with the lowest balance one and pay that off, then go through the list to the next, etc. The reasoning goes that it is a little emotional reward - that you can see progress in actual loans/accounts being paid off.

Dave Ramsey has a name for it. Debt snowball or something - like a small snowball rolling and gathering size.

Either way, keep it up.

EDIT: note - the difference in the two strategies is not likely to be much money. The real issues is to pay off as much as you can as quickly as you can.

Answer 5

Any of the ways to pay down your credit cards mentioned already will get you debt-free.

I'd like to offer a side method: Increase your income. You'll have more money per month to throw at those debts.

Start a blog on your debt reduction. "Watch me go from $XX,XXX in debt to zero in three years." Sign up for a Google AdSense account after your blog is off the ground and put the ads on your site. Those keywords pay very well. (Don't click on your own ads or tell others to click on them, though!) Submit your debt reduction posts to the Carnival of Debt Reduction.

Answer 6

You do not say where you are located so my answer is specific to the UK. It may have relevance to other countries if similar products are available.

In the UK the credit card companies often have special offers to attract new customers. These are usually something like 0% interest on balance transfers for 12 or 16 months after account opening, usually for a 3% fee. To reduce the total amount payable you should open one of these accounts and transfer the balances from your highest rate cards to this new card. Then pay off the remainder while keeping to the minimum payment on the new card.

Martin Lewis is a financial journalist in the UK with lots of good advice on this.

Answer 7

I've actually wrote a spreadsheet that allows the simulation of various payoff scenarios. Here's some general findings:

1. Myth of 'pay off the loan with highest interest' is most often wrong.
2. Myth of 'pay off the smallest one first so you can use the money toward paying off the other loans' is also usually wrong.
3. Calculate which loan at the end would generate the most interest. That's the one to pay off first. The same amount of overpaying on the biggest interest-generator has the greatest effect at the end.
4. The allocation of payoffs toward some scenarios does not always result in a clear-cut solution. Sometimes the optimal solution is 'in the middle' and you do not benefit from dumping all the extra funds into one loan, but you need to spread it around unevenly. This is what humans are horrible at spotting, but a Solver in Excel will do wonders for you in seconds.