By Andrew Housser
Nobody likes receiving credit card bills, and so when the due date rolls around, it can be all too tempting to write a check or enter an online payment for just the minimum amount. But before you click "submit payment," you might want to think about some different strategies that will pay your total debt off faster.
First, consider these two points:
1) Imagine you have a credit card debt of $10,000 with a 19.9 percent interest rate. In this case, a standard minimum payment of 3 percent of the monthly balance would be $300 per month. Suppose you always pay only the minimum payment, without adding more to the balance, until you have paid the debt in full. The minimum payment will decrease over time as your balance decreases, going down to $50 per month, for example, as the balance goes down. You'll be paying this credit card bill every month for 15 years, and repayment will cost you more than $21,000.
2) On the other hand, if you are able to pay more than the minimum payment, you can save hundreds or thousands of dollars in interest. As a bonus, you will clear out your debt in far less time. Let's look at the same scenario as above ($10,000 debt and 19.9 percent interest rate). If you decide you can pay $500 per month, every month, you would save substantially. In fact, you would pay a total of only $12,250 -- and become debt-free in just two years. In fact, you would save almost $9,000 and cut off 13 years of payments!
Just imagine what you could do with your extra money if you got out of debt 13 years sooner. Not to mention that you can probably think of a few things to do with the $9,000 you would save.
Which debt payoff method is better -- avalanche or snowball?
You can use one of two strategies for best results -- the avalanche or the snowball. Both work. The one you choose will depend on what motivates you best.
To be effective with either strategy, you should plan to pay a fixed monthly amount toward your debt until all debts have been paid off. You will need to be able to afford an amount that is more than the combined minimum payments on all of your cards. How you allocate that fixed monthly amount among your cards depends on which strategy you choose:
1) Avalanche
The avalanche method involves paying off your credit cards by starting with the one with the highest interest rate, and working down from there. First, decide how much you can afford each month. From that total, make minimum payments on every credit card except the one with the highest interest rate. For that card's bill, pay the minimum plus any extra you can afford. Repeat this process every month until that credit card has been paid off. Then, keep paying the same monthly total -- but take every dollar you were using to pay off the highest-interest card and put that towards paying off the card with the second-highest interest rate. Keep following this strategy until you've cleared away all your debts.
2) Snowball
The snowball method involves paying off the smallest debt amount first, and working up from there. First, just as you would with the avalanche method, budget enough money to pay the minimum on all cards. Then apply any remaining funds toward paying off the credit card with the smallest balance. After you pay off that first credit card, continue paying the same monthly amount you started with. Follow the same strategy as before: Pay the minimum on all most cards, but pay all your remaining funds to knock out your second-smallest debt faster.
The snowball method can be more costly than the avalanche method, because you might pay more interest over the long run. But many people find that the success of paying down small debts helps motivate them to stick to the plan of paying down all debts. Some recent academic studies have confirmed this hypothesis. If you are not extremely self-disciplined, consider the snowball over the avalanche method, as it will likely increase your chances of success.
On the other hand, if you enjoy knowing you are beating the banks out of some of the interest they charge, and know you can stick with the plan, it could be more rewarding for you to go with the avalanche method.
Either way, you will ultimately come out a winner when you get out of debt. Any time you receive that credit card statement showing you have no balance remaining on an account, you are sure to feel successful. Then you can turn that feeling of success into motivation to keep paying off any other debt -- and to start saving for your future.
Whether you attack your debt with an avalanche or a snowball could drastically alter your final payments. (©iStockphoto/Thinkstock)
Andrew Housser is a co-founder and CEO of Bills.com, a free one-stop online portal where consumers can educate themselves about personal finance issues and compare financial products and services. He also is co-CEO of Freedom Financial Network, LLC providing comprehensive consumer credit advocacy and debt relief services. Housser holds a Master of Business Administration degree from Stanford University and Bachelor of Arts degree from Dartmouth College.
