In today’s world, taking on debt has become a part of life. While most people will say that they simply can’t live without using their credit cards, I would simply disagree. In fact, millions and even billions of people centuries before us made it just fine without any such financial instrument. The reality is that most of us just need to cut back and get back to basics. If you’re in agreement with me and want to eliminate your credit card debt, I’m going to show you the best way forward. But before we do that, let’s look at a simple idea and a few simple scenarios.
The way out of credit card debt is simple; stop taking on debt. After that the strategy is easy as well, pay down the account that is charging you the most total interest not the highest interest rate. Here are some examples to illustrate my point.
Credit Card Account Example 1
Credit Card 1: $800 balance accruing 19% interest
Credit Card 2: $800 balance accruing 17% interest
In this example, you would pay off the higher interest rate card first (credit card 1) because the balances are the same so the higher interest rate costs you more ($152 vs. $136). This isn’t always the case.
Credit Card Account Example 2
Credit Card 1: $400 balance accruing 19% interest
Credit Card 2: $1000 balance accruing 15% interest
In this example, you would pay off the higher balance first (credit card 2) because your total interest charge is higher than the card charging the higher interest rate ($150 vs. $76).
Now let’s look at a more realistic and complex scenario to illustrate how this all comes together.
Credit Card Account Example 3
Credit Card 1: $4,500 balance accruing 14% interest
Credit Card 2: $500 balance accruing 19% interest
Credit Card 3: $800 balance accruing 16% interest
Credit Card 4: $1,200 balance accruing 15% interest
In this example, I would pay down the balance on credit card one first. The reason for this is simple; since it is the credit card with the highest balance, it is also costing the most money in total interest. Many financial experts will advise you to pay down the cards on your highest interest bearing credit cards first. In my opinion, this is bad advice. You see, 14% interest accruing on a $4,500 credit card account is costing you an additional $630 per year in interest charges. The 19% interest accruing on the $500 balance only costs you $95, which is much less money even though the interest rate is higher. Even if you add up the additional interest charges of the other 3 cards combined, the total interest is only $403! This is still less than $630 per year. Now let’s look at a pay down example to show how to pay down these debts in the best way possible.
Let’s say you can save and additional $300 per month from your paycheck by cutting down on eating out and morning coffee runs. By the way, it is very realistic to reach this number by only doing these couple of easy things. Once you realize that you can achieve this, you make a pay down plan. As we’ve discussed and shown here, you want to put that money to work on the largest interest accumulating account (in this example its credit card 1). This means that you would pay the extra $300 per month towards credit card 1 only. It also assumes you can still make the minimum payments on the other 3 cards. You must keep paying the minimums on those so you don’t hurt your credit score!
Doing this means that you will pay $300 per month to credit card 1 for roughly 15 months. Next you would start the same process on credit card 4 and pay that off in roughly 3 months. You would finish by paying off the last two cards, number 3 first and then number 2 based on our system. Of course this is a simplified model and also assumes that you aren’t taking on more debt for any of these credit cards. This example should still make it clear enough to you about the best approach to pay off your credit cards and save a lot of money in interest payments.
Paying off your credit cards can be a daunting task and one that is more of a marathon than a sprint. It requires a lot of patience and dedication to see it through but if you follow these steps, you’ll pay them off and end up wealthier than those who never pay them off or don’t pay them down with this type of pay down plan.