Which Credit Card Payoff strategy is right for you?
If you’ve ever found yourself paying a lot towards your credit card balances, only to feel like you aren’t making much progress towards the total balance, you are not alone.
It becomes especially hard to make progress if you are actively using those cards for new purchases.
When you have multiple credit cards or other debts, it can be confusing knowing which one to focus on, or if you should try to make progress on all of them simultaneously.
Creating a plan
You are more likely to make progress when you have a clear plan. When it comes to debt payoff, the two big questions are
1. How much extra can you pay?
2. Which balance should you focus on first?
How much extra can you pay?
The first step is to ensure that you can make the minimum monthly payments consistently. Not making those minimum payments on time can lead to fees or other consequences (which will be covered in a later post).
Assuming you can make those minimum payments, is there any money left to make additional payments? If you have cards with high-interest rates (anything over 20%) and are only making the minimum payments, it’s going to take a long time to pay off the balance, and you will pay a lot in interest fees along the way.
You may determine that you have room in your budget to add an extra $100 a month to pay down debt. Or maybe you really can’t commit to paying more than the minimum each month, but can commit to putting a portion of any extra money that comes in (overtime pay, side hustle income, annual bonus, or tax refund) toward your debt.
There more you can put (above and beyond the minimum payments) the better, whether that’s small consistent payments or occasional larger chunks.
Some people go with the “if I have any money left at the end of the month, I’ll put that towards debt” strategy. That CAN work and is better than not attempting to pay anything extra. However, the “I’ll see what's left” approach means that all your other expenses take priority. It shouldn’t be a huge surprise when often there isn’t much left at the end of the month.
Instead, if you articulate a specific plan of how much you will commit towards debt payoff you are likely to make more progress. If you can automate it (set up an automatic transfer every month) then you’ll make it much easier to stick with your plan.
What balance should you focus on first?
Without a specific plan, people will often throw any extra money at accounts in a very random or spontaneous way. If instead, you pick one card or one debt balance to put all of your energy into first, then move on to another, your progress will be more noticeable.
Being able to see your progress makes it more satisfying to stick with the plan. And while there is some math involved in picking a debt payoff strategy, I’d argue there is a lot more psychology involved.
There are a few different strategies for picking which debt to tackle first. Some people argue that there is a “right” approach, but I think it’s important to consider which is the right approach for YOU.
Avalanche Method
With the Avalanche Method, you will focus your efforts on the card with the highest balance first. If you have 3 cards with a 15% APR, a 22% APR and a 29% APR, you’ll pay the minimums on the 15% and 22% cards, and then the minimum + any extra you can afford towards the 29% card. So if you can afford an extra $100/month, that extra $100 goes to the 29% card. Or if you are putting your annual $1,000 bonus towards debt, you’ll make the minimum payments on all the cards all year, then add an extra $1,000 to the 29% card when you get that bonus.
Once the 29% balance is fully paid off, you’ll put the amount you were paying towards that card (the minimum + whatever extra you can afford) to the 22% card. Once the 21% card is fully paid off, you’ll put all of that money towards the 15% card. The amount you are putting towards your debt each month stays the same until the final card is paid off.
The interest on the 29% card costs you more than the interest on the other cards, so by putting all your effort into this card you will pay less in interest and (assuming you stick with the payoff plan) you’ll have all 3 cards paid off the fastest with the Avalanche method.
This is the most mathematically optimal strategy, so if saving the most on interest payments, or doing what the math suggests is motivating to you, this is a good strategy to consider.
Snowball Method
With the Snowball Method, you are focused on paying off the card with the lowest balance first. The goal is to get one card/debt knocked out as quickly as possible. Getting a card paid off, even if it has a low balance or has a low APR, provides a feeling of accomplishment. Long-term goals are hard to stick with. This strategy ensures that your first milestone isn’t too far off, which makes it easier to stay motivated.
This approach also helps reduce the number of total debts more quickly. For many people, having lots of payments to manage is overwhelming. This strategy helps to reduce the cluttered feeling when you have lots of smaller debts.
If you have 3 cards, with balances of $5,000, $3,000, and $1,000, you would put your extra money (beyond the minimum payment) towards the card with the $1,000 balance. Once that one is paid off, you would keep paying the same total amount towards debt, but shifting focus to the $3,000 balance card. So you would pay the minimum on the $5,000 card, then everything else would go to the $3,000 card.
If reducing the total number of debts is enticing, or if you know that longer-term goals are challenging to stick with, this may be the method for you.
Emotional Baggage Method
Similar to the Snowball Method, the Emotional Baggage Method is focused on keeping you motivated. If you have several different debts, they likely all have a different story for how/why they accumulated. Often we have different feelings about where the debts came from or the reasons the debts built up. If one of the specific debts brings up strong negative emotions every time you have to make a payment you may be more motivated to get rid of that one faster, even if the math suggests you should focus on a different one.
Let’s say for example, you have $1,000 on a card that was from an amazing trip you went on last year with your best friend, $5,000 that built up when you were between jobs earlier this year, and $3,000 from when you and your ex bought a couch, but then broke up a month later, and he ended up keeping the couch because it didn’t fit into your new apartment. You may feel very different emotions when you make your monthly payment on each card.
Getting rid of the balance on the card that bought your ex a new couch may be more impactful for you than paying off the card that paid for your amazing trip. If you are more motivated to get rid of the couch card, you may actually make more progress if you focus your energy there.
Regardless of the speed of your overall debt payoff journey, getting to a point where you don’t cringe looking at your credit card statements anymore is an important milestone that shouldn’t be overlooked.
Picking the best option for you
While I think it’s important to understand the math behind the different options (how long different approaches will take you, and how much more/less you’ll pay in interest), I think the most important factor to consider is your interest and motivation. If you are motivated, possibly even excited, to pay off a particular debt, it will be much easier to stick to your plan. You may even find ways to get there faster than your original plan. However, if the process feels boring, or puts you in a bad mood, the odds of you bailing on your debt payoff plan increase.
A mathematically optimized plan is not better if you give up on it a few months in.
Build a savings safety net
While working to pay off your debt, it is important to build up your savings safety net, too.
Sometimes people question if having money in a savings account, while working to payoff debt, makes sense. If you keep $1,000 in a savings account instead of putting it towards your debt, you are indeed paying more in interest fees. From a purely mathematical perspective, putting every penny available towards your debt does make sense.
However, not having any savings buffer means that when an unexpected expense pops up (which it inevitably will), you won’t have the money to pay for it in your checking or savings account. You will likely end up using a credit card to cover that surprise cost.
When you are aggressively paying down your debts, only to have the balance rise again after this unexpected expense, it's incredibly de-motivating. This is where a lot of people start to feel discouraged and give up their debt payoff plan.
If keeping a small savings buffer costs you a little bit extra in interest payments, but allows you to cope with unexpected costs in a way that doesn’t derail your progress, that it is a worthwhile expense.
Resources
Being able to see how the math plays out in different scenarios can be really helpful. The PowerPay tool (created by Utah State University) allows you to plug in all your debts and any additional payments you can make (recurring or one-offs). Then it shows you how the order in which you prioritize that extra money will impact the overall timeline and total amount paid.
This tool is free, but you do need to create an account to use it. It only takes a minute to set up your account, and fortunately, once you create an account they won’t spam you with unsolicited emails.
Determining how much extra you can afford
For many people, the most challenging component is understanding how much they can afford to pay their debt each month. It’s common for people to try to pay down their debts aggressively, only to find that they’ve run out of money by the end of the month and need to put their essential expenses on another card to get by until payday.
If you would like support in creating a sustainable debt payoff plan, that doesn’t result in you living in total deprivation, schedule a call with Sarah to learn more about 1:1 coaching support.
