The question comes up all the time when a person wants to start getting their credit cards under control – Pay off the cards with the highest interest or the cards with the highest balance?
On the one and you have high interest credit cards – A high interest rate costs you every month and compounds the amount you owe every month you aren’t paying off the entire balance. High interest costs you for what you borrowed. For some people the interest rate can close in on 30%. That’s basically agreeing to pay one third more for everything you bought on the card (or more depending on how long you owe)!
On the other hand you have high balance cards – You’ve used the card so much that the balance may be in the thousands and no matter what you are paying the balance doesn’t seem to ever go down. Even if you have a low interest rate you may be paying a lot of interest because of your high balance.
So which do you pay off first?
This can get to be a tough question for someone who isn’t particularly great with their personal finances. Your trying to do the right thing and want to make the most effect on your credit card balances. What to do? I remember when I first got serious about getting out of credit card debt this was an issue that plagued me. Pay more to the highest balance or pay more to the highest interest? Am I losing out if I pick the wrong one? I need every dollar to be used most effectively!
Analysis Paralysis
This is where people get frustrated about personal finance. There is no one answer in every instance that is always correct. For some people paying off the highest balance is most effective while for others paying off the highest interest is best (for some one card is both so go pay it off already!).
The problem with open choices like this is it leads a person to analysis paralysis! You start to look at the choices and do you best at analyzing which is best but in the meantime you’re unable to make a decision. You waste time flipping through all the possibilities. When you see all the options you get frustrated and give up! Really it happens. So what to do?
It doesn’t matter, just pick one!
If you’re neck deep in credit card problems then you need to take action! Any action! Odds are your discipline isn’t exactly the best with credit cards (admit it, it sucks!). You need to tackle your credit card bills and see some positive results.
Open your wallet. Grab the first credit card you see. That’s the one you are paying off! Pay the minimum on all the rest and pay everything you can into the one credit card you grabbed. Knock it out! I’m telling you it will feel great once that one card has a zero balance! Then take everything you were paying on that card and apply it to the next card. Which card next? Doesn’t matter, remember? Grab the next card in your wallet. It may take some time but you will get those cards paid off!
You sound like you you want to be Dave Ramsey but just don’t want those anti-dave ramsey people against you. He has similar advice except that he pays the card with the smallest balance first. That’s the quickest way to get rid of one card at a time.
I’ll be honest with you, I’ve certainly heard of Dave Ramsey but I’ve never read his stuff or seen his show. The idea of going after on credit card first isn’t new and it’s what I did when I attacked my debt years ago.
I always went by the rule of paying off the card with the highest interest rate first since you’ll pay less interest in the end. But I can also understand Dave Ramsey’s point about the psychological boost you get by paying off the smaller balances first and building momentum from there. I’m not sure what the benefit of paying the highest balance off first would be.
.-= Saving Money Today´s last blog ..Is It Always Worth It To Go Back And Complain? =-.
It depends on what your interest rate is and what your balance is as for what the most interest you’re paying is. You can have a high interest card with a small balance that has less interest accumulating than a higher balance card with lower interest. This is where it can get confusing and why I say just grab one and start paying it off.
I created a table in which I made 4 paymens $100, $500, $300, $200 across 3 debts of $2000 at 5% (100), $1200 at 15% (180), and $400 at 20% (80). My first table was based on paying off the card with the biggest cost at the end of the month (180) and recalculating after each payment. After 4 payments my remaining interest cost was about $225.
Then I repeated the same table paying of the highest interest first. In two payments I was already down to about $225. The 80 expense was wiped out in 1.6 payments. When I saw what my table looked like I couldn’t believe it. So I calculated what happened. Even though the 400 is not a whole lot it only represented 11% of my debt, it represented 22% of my total debt cost.
Now that deals with actual numbers. However, like someone pointed out… if from a Psycology stand point you need to pay off smaller balances (or whatever) first then do it. The goal is to pay it off as quick as YOU can.
It’s not the highest balance that should be paid off; it’s the balance with the highest interest. While I can understand some people need the encouragement of paying off smaller ballances first, no matter what the interest rate, I just could not bring myself to do that. I’d feel like I was shooting myself in the foot. Why pay extra interest just to fool yourself into thinking you are doing it the right way? Man up, and do the right thing. Pay off the high interest debt first.
Thing is, most of us need a kind of life hack in some way to “trick” ourselves into doing the right thing. The brain is this wicked-crazy thing that isn’t always rational (look at our economy in general and you’ll see that’s true).
If you are one that will calculate exactly which card is best to pay off then the question posed in this article is moot to you. What I’m aiming to do is to help those who want to do the right thing but find themselves stuck. Just do it! Pay something off. Get some momentum moving.
Personal finance is a process and we all move at different rates. You have to do what works for you.
Glen, I get your point. When it comes to money I’m pretty disciplined–had it drummed into me by my parents. Now when it comes to dieting my brain becomes truly wicked. I can start a reasonable diet & end up gaining weight! My brain can rationalize anything when it comes to food. I do much better controlling my weight by trying to do what I can about food here & there & trying to eat healthy in general. If someone is like that when it comes to debt I can see where it would be best to just do something to get the momentum going. Now if someone could just come up with a way to program our brains to do the right thing in troublesome areas . . . Ha!
You’re right: What’s best for your, from a mathematical standpoint, is not necessarily what will work best for you. And I think trying to decide those sorts of things are really, really difficult for people.
For me, it was always common sense: Pay off the highest interest first. It’s costing you more. But I understand how much psychology can affect success. So do what you think will work the best.
And people forget: It’s not like you’re signing a contract. You can switch. If paying off the highest interest card is discouraging, try Dave Ramsey’s way. You’re allowed to experiment with what works. I think people forget that hard and fast rules can bend to accommodate personal tendencies. What matters is finding what works for you, not what some financial guru says is best for you.
I think with personal finance, what gets some people is that there isn’t always one answer that is correct. The end goals may be the same but how you get there can be different. For someone who’s credit cards are out of hand I think you need to take action and go from there.
I recently refinanced a mortgage and was trying to determine whether I should put extra principal towards a loan with lower interest and a higher balance or a loan with higher interest and a lower balance. After doing some simple calculations I have to agree with Maggie. Numbers don’t lie, and paying off the higher interest rate loan is the best method (even if the difference in balances is over $100k). Impulsive actions are what get people into consumer debt in the first place, and paying off the first card in your wallet if it isn’t the highest interest rate card will only prolong the debt cycle.
You’re right, the numbers don’t lie and it makes logical sense to put your money where the calculations make the biggest dent. But unfortunately we’re not all logical when it comes to our money. You have to consider the fact that some people have many credit cards with a balance on them. Being able to pay just one off, whatever the balance, is a huge motivational boost. Regardless of the numbers I’d much rather see someone start then get stuck trying to figure out the best place to start paying off the most.
There is one other thing, though. The main thing is getting the cards paid off, yes. BUT, paying the minimum on ANY card is bad for your credit score. At least pay 1 or 2 $ above the minimum on every card, which makes your credit score look better over the long haul. Also, paying more then the minimum consistently makes you eligible for lovely things like rate DECREASES! Some CC companies automatically increase your limit (better utility score on your credit, which improves your credit, which prevents universal default hikes) or reduce your interest rate incrementally depending on how many consecutive months you pay more than the minimum (reducing overall interest cost and debt). Please note that there is no particular amount above the minimum one must pay – it can only be a couple of dollars extra per card, but that can add up to help also.
That’s an interesting impact. I’ll have to look into the effect of paying a bit more than the minimum.
You have to watch out for limit increases though. It can improve your debt to credit limit ratio but for someone who is bad with their cards it can be adding fuel to their spending fire.
That’s uneducated BS.
Paying the minimum is not bad for credit, and paying $1 above minimum will not make any difference.
I think your last point is best – it doesn’ t really matter! Just do it! (That tag line works for so many things.) As long as you are making progress on getting rid of debt, you are making a good decision.
I would go with the highest interest rate first. However, if you find yourself discouraged and you have one card with a fairly low balance – switch to paying that off. Get it done so you have the sense of accomplishment and then go back to paying on the high interest card!
When I was in debt, it felt like paying it off was an insurmountable mountain! My payments would go out but the amounts wouldn’t change. Knocking off debt from one card can help so much in building up confidence that a person CAN pay off all of their credit card debt.
I hate thinking about paying off the one with the lowest balance first, regardless of interest rates. I can’t stand thinking about money on the table. But that’s probably also why I’m not neck deep in debt.
I still think that if you’re making a decision to be responsible, you should do the most responsible thing and lower your overall bill.
What do you think about a hybrid? Do the lowest balance first, and when that first debt is fully paid, you have the motivation, so switch to highest interest?
.-= Daniel´s last blog ..Personal Finance 101 =-.
I think it’s whatever is easiest and what works for you! If you can do the calculations and figure out where the most impact is then go for it but my point here is that a person who got themselves in this situation in the first place may not be thinking about the best financial decision to make. They need to get moving and attack their debt. As a comment said above, you don’t have to stick with this plan. If you want to find another way that works for you then go ahead, as along as you are still working to knock out your debt.
Good advice here.
I did a little math recently and found out that I pay something like $7 PER DAY in finance charges. Add it all up and we’re talking about enough for a vacation each year. I’ve learned my lesson and am working on paying this off.
In the latest podcast episode over at LifeTuner, we also talk about the impact of new credit card law changes, what sort of new fees and other changes to expect from your credit card company in response, and how to protect yourself from getting burned.
Worth a listen:
http://www.lifetuner.org/blog/244-podcast_dont_get_burned_by_new_credit_card_changes
$7 a day, huh? That is a sobering amount to be paying in finance charges. Good luck on paying off your debt!
Ignorance is bliss. Many people get and stay in debt because they don’t pay attention to the details. Most probably don’t even open the statements. I know didn’t! I was over $30k in debt and had no idea. Interest rates? Who cared as long as I could make the minimum payments.
Then along came Dave Ramsey and everything changed. It was a great starting point for my journey to living debt free, but I realized after reading hundreds of blog posts on PF and frugality that I was throwing away hundreds of dollars in finance charges by paying the smaller debts first. I gave up the baby steps and developed my own plan. The best part is my budget includes a night out every week. (I HATE beans and rice!)
I think you are correct about most people not wanting to know the details. Even when a person tried to find them out they may not realize all of the details as the credit card companies make them hard to know.
Its great to hear you are on your way to being debt-free!
Why not pay of both the high interest cards, as well as the cards with the largest balance? Just split your payment.
.-= James ´s last blog ..Sunk Costs =-.
You can do that. But you might not see the same psychological impact as you would paying everything to one card.
When I began my debt freedom journey I went with the highest interest rate first because that’s what the math says to do.
Years later I found Dave Ramsey and listened to his point, if I were to do it again I would take his approach and begin with the smallest. The psychological benefits in retrospect would have been really helpful!
.-= LeanLifeCoach´s last blog ..Combat The Closing Techniques – The Puppy Dog Close =-.
Again, I think whatever works is what you go with. I spent time wondering where I should be making the most payments and it kinda drove me nuts. Just do it!
I say pay the smaller ones first..get the benefit of quick wins.
.-= Ken´s last blog ..Weekend Linkage – Olympic Edition =-.
Knowing you CAN pay off your cards is a great confidence booster!
We went with smallest- to get it out of the way. Then with the one that hurt the most. It ended up being our highest APR card- but it was also the one that lowered our credit limit and sky rocketed our APR the exact month we really needed the extra buffer. So I went small, then emotional, and now highest interest rate. Not exactly the smartest math, but lowered my stress and got my mojo back.
.-= Ted´s last blog ..Boo to credit card companies =-.
Yeah, it’s not always about the math, it’s what gets you doing it and what works for you!
And when you pay one off, get out the scissors and cut it up! I also agree with the first commenter–pay off the smallest balance card first and get a victory under your belt.
Keep in mind cutting up a card doesn’t get rid of it! But it can give you a sense of psychological accomplishment.
Step 1 – Set aside $1000 for an emergency fund to help prevent having to add charges back to your credit card.
Step 2 – Pay off debts from smallest to largest for a psychological boost while getting out of debt. This can be a little flexible and you can also use the “pay off list” technique to try to negotiate a debt settlement for large savings. Call your creditors and tell them you have a plan to pay off debt and they are X on the list. You are willing to move them up on the list for a settlement amount. If they decline, politely tell them you will get to them when you plan dictates. In the end, behavior modification is the real end goal. Deciding not to live beyond ones means is critical to long term wealth accumulation.
An emergency fund is always critical but you have to consider the fact that many people get into credit card debt not because of emergencies but because of impulse spending which you hit on in your second point. It really is about changing the way you think and act about spending.
I would look at all my credit card statements and focus on the card with the “highest interest payment” each month in dollars. That could be the highest balance card or the highest interest rate card or one in between. The card you’re paying the most interest in dollars to is the one that’s sucking you dry the fastest.
That’s a great way to working on it!
That is not true, the one with the highest apr is sucking you dry the fastest. If you have a 100k mortgage @ 3% apr, and a $100 on a visa @ 30% apr, then they would cost you $3,000 and $30 in interest per year respectively. Say you have only $100 to spend, and won’t incur any fees other than interest. If you pay the highest interest payment it would be the mortgage. If you pay the mortgage you now have $99,900 @ 3% and still $100 visa @ 30%. If instead you pay off the visa bill, you now have $100,000 @ 3%. In both scenarios you have at least $99,900 mortgage debt @3% apr, the only difference is the last $100 is at 3% in one scenario and 30% in the other.
That is always the case. If you could somehow make one of the debts disappear then you would definately choose the mortgage, but you can’t just disappear it, you can only pay off X amount of debt in a given time and it should always be the higher APR.
> I need every dollar to be used most effectively!
That is a clear requirement. It also means that the requirement is NOT: “I want to have fun”, or “I want to FEEL like I am making more progress”.
In short, for maximum effectiveness, you need to drop the emotions and laser-focus on what is mathematically the best solution. In this case: Pay off the highest interest debt. Then the next highest, etc.
Shouldn’t you be reading the statements like a hawk anyhow? How hard is to order by a percentage?
Your points are well-made but spending IS an emotional act. If we could all remove emotions from spending then I think you wouldn’t hear about high credit card balances with late fees and such. When a person is finally waking up to the fact that they need to do something about their credit card debt it helps to have the psychological boost of paying off a card. As a person builds better habits and changes their mindset then they can examine their statements in detail.
“I am an recovering alcoholic. Should I stop drinking wine? Or tequila? Maybe if I stop drinking Jaegermeister for a week,I’ll have beer!”
Reality check:
If you are in this situation, that means that you let emotions win over logic, in the first place.
So: QUIT DOING WHAT DOESN’T WORK!
The ONLY way to dig your way out of a mess is to:
– Make a detailed plan to fix the debt problem
– Execute the plan EXACTLY, by the cent.
Sorry to sound overly strict, but it’s the only thing that works. Doing ANYTHING else than the plan is throwing away money, which is what caused the problem in the first place.
I love this blog, but this article is not really helping the cause. A link to some online resources to create a plan would help people more.
I appreciate your views but there is no one plan that always works for everyone. The point here is that there are people who get into credit card debt and have a spending problem. At some point they realize things are bad and finally want to make a change but get confused on where to start. My simple plan is to get people on their way to taking care of their debt. DO something. Build up your confidence that you can change your debt level and your spending plan.
Creating a plan is a great idea, but its making the plan and implementing it that throws people off. Emotions may play a large role, yes, but you can’t shut that part of your brain off like a switch, at least not for most.
I totally agree. Paying of high interest credit card debt should be your first priority, otherwise this will build up overtime if not attended to.
An additional argument for paying off a smaller balance is that you can take the freed up money and apply it toward the higher interest rate. So if you can combine the confidence boost of making tangible progress with the new additional financial amunition, you actually are not coming out behind because you now can pay off the higher interest at a rate faster than you could if you had not paid off the smaller balance first.
ALTERNATIVE PLAN:
I think the best thing to do first is STOP USING THE ONES THAT DO NOTHING FOR YOU.
i.e Target gives you 5% discount rate on your TP and Shampoo, etc…stuff you buy anyway. This keeps your credit active.
Just pay the balance EVERY MONTH or the discount eradicates itself.
The other BIG THING is credit score.
Basic Formula I was taught is that you do not want to exceed 30% of your available credit limit.
Make a budget…SEE WHAT YOU CAN AFFORD TO PUT TO CARDS.
So LOCK UP MOST OF YOUR CARDS IN SAFE PLACE. (then if an emergency comes up or situation…you have some options when the balances come down)
SET UP AUTO PAYMENTS>>>so you don’t miss payments…and eventually get a few cards below that 30% mark. Be sure they are above the minimum payment across the board if you can.
Use one card for your TP and Shampoo…one for your gas.
If you get a larger some of $ in…PAY MORE OFF!!!
Then…what a concept…Start Putting the $ in Savings…or if you built your credit…towards that house payment.
I am back in the hole again after an emergency needed airline ticket…and a vet bill.
But I know I have gotten out…and I will again. But had I not paid…I would not have had the credit for emergencies!
I got to the point where I had a savings…it went to a down, an appraiser, and an inspector, etc…
I don’t have a large income, but by keeping my balances low (not zero) and paying on time, I got a decent rate on a home. My mortgage is less than my rent was…and I have garage and another bedroom now.
IT TOOK A LONG TIME!!!
I worked 6 years at it.
So don’t give up…stuff happens…sometimes you have to dip back into your credit….but just get right back to lowering it again.
IF YOU HAVE MAJOR COLLECTIONS>>>SETTLEMENT CAN OFTEN WORK
if you get a lump sum of money after being in collections…take that amount…split it up at about 60 percent per debt…offer them 40% and then they will often talk you back up to that 60 and be able to accept it.
Once that happens, if you can swing it…watch out…because you will get NEW CARD OFFERS. Be careful to not do it all over again.
GOOD LUCK!!!
I definitely agreed on the last one, it doesn’t matter just choose one, when the bills come get your cash and pay it off rather than waiting for the due and deadlines. It feels so great if you see zero balance in your bill! Having a credit card is very helpful especially for emergency buys and large purchases, nevertheless you as a credit cards owner should always be responsible enough to pay for your bills.
Good point. When you aren’t carrying a balance a credit card can act as a backup in emergencies and when you have the cash it can be used for large purchases. This is harder to do when you are already carrying balances.
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