straegies to pay off your cedit
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Geoff Williams, Contributor | Oct. 20, 2014, at 10:39 a.m.
These common strategies can help cut your mounting debt, even when your funds are low. (iStockPhoto)
If your monthly to-do list includes dedicating a chunk of
change to your credit card balance – or multiple balances – you’re not
alone. Approximately 4 in 10 Americans carry revolving debt
on their credit cards, according to a 2012 survey by the National
Foundation for Credit Card Counseling and the Network Branded Prepaid
Card Association. And although the average debt varies by source, credit
reporting agency TransUnion puts the sum at $4,878, not including
zero-balance cards and retail credit cards.
There are only so many ways to pay off a credit card
if you have a significant amount of debt and an insignificant amount of
money. But here are the three common strategies people in your
situation employ, along with what you need to know about each option.
Focus on the card with the highest interest rate.
Most financial experts say this is the way to go. Scott Halliwell, a
certified financial planner at USAA, a financial services company that
specializes in helping the military, speaks for many when he says: "The
best move from a purely financial perspective is to attack the highest-interest rate cards first."
It makes sense. The card with the highest interest rate
is usually the one that will cause you the most financial pain. The
national average interest rate on a credit card is 15.2 percent, so if
you bought a $1,000 refrigerator with a credit card, you'd pay a lot in
interest if you took your time paying it off. Most monthly payments are 4
percent to 5 percent of the balance, so if you're making a $40 to $50
monthly payment, you can see how things can get bad in a hurry. Only
making $40 monthly payments on that $1,000 refrigerator means you’ll pay
it off in 65 months and shell out $368 in interest.
So focus on paying off that high-interest credit card
while at least making the minimum payments on your other cards. Once
you’ve accomplished that, Halliwell says, "roll all the money you were
applying to [the highest-interest card] each month to the debt with the
next-highest interest rate. And so goes the process until all the debt
is eliminated."
But beware: This is a responsible approach, but it can be a slow one. If you're buried under a lot of revolving debt and living paycheck to paycheck,
you may get overwhelmed by how slowly it's taking to pay everything
off. Then, like a dieter falling off the wagon, you may end up using
your credit cards and adding even more revolving debt.
Aim for the card with the smallest balance. If
you're someone who likes to see progress, try what Zev Fried, a
financial adviser with JSF Financial Services in Los Angeles, calls the
“snowball” strategy.
It involves paying off the credit card with the smallest
balance first while, of course, continuing to pay at least the minimum
balance on your other credit cards. Once you’ve done that, take the
extra money you now have every month and apply it to the credit card
with the next-smallest balance. After that one’s finally paid off, you
should have even more money to hurl at any other credit cards. Your
extra money snowballs and eventually overpowers the debt on that last
credit card.
"Generally, we recommend clients estimate the most
expensive debt first since they will pay less interest," Fried says.
"However, the snowball method's value is psychological and behavioral.
It feels good to see an account at zero. This often motivates them to
stick with the program and become debt-free."
Passard Dean, an associate professor of accounting at
Saint Leo University in Saint Leo, Florida, and a former employee at the
credit reporting agency Equifax, also likes the snowball method. "While
it may make more logical sense to attempt to pay off the card with the
highest balance to save on total interest paid, we need to be cognizant
of the fact that we like to accomplish short-term goals, and the card
with the highest rate may not be the one with the lowest balance," he
says.
But beware: As Fried says, in the long run, you will probably pay more in interest.
Target somewhere in between. If you have $300 to
throw at debt on four credit cards, and it makes you feel better to hurl
equal amounts at each card, that's fine if it keeps you on track –
provided you're making at least the minimum payment for the cards and
preferably paying more than the finance charge. The finance charge is
the fee that makes up the interest you accrue every month if your card isn't paid off in full by the payment due date.
"It really does depend on how the person is wired and
which method will keep them motivated until the finish line," says Gail
Cunningham, spokeswoman for the National Foundation for Credit
Counseling.
But beware. Since you're acting on emotion, and
your strategy is more reliant on what feels right, make sure you're
paying your bills on time. That's important no matter how you pay off
your credit cards, because late fees
will just make your debt fatter and possibly cause your interest to
climb. Since this approach will probably be the slowest one, paying on
time is even more vital.
Also, you need to look at that finance charge as much as
you do the minimum payment, says Rakesh Gupta, a business professor at
Adelphi University in Garden City, New York, who teaches a freshman
seminar called "Your Money and Your Life."
"Some credit cards' minimum payments are less than the
finance charge," Gupta says. So if that's the case, and you pay the
minimum but the finance charge is higher, "you wind up paying interest
on the interest," he says.
What to Do If You've Fallen (Way) Behind on Your Credit Card Payments
The short answer is yes, but not for the reason you may think.
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