How to calculate which credit card to pay off first
When you're ready to pay off your credit cards, selecting the right credit card to pay off first may help you build a strong debt repayment strategy, as well as help you plan for credit card usage in the future.
There are a number of simple ways to insert a credit card debt repayment strategy into your life. Ahead, you'll find a few different methods that may help you decide which credit card balance to pay first and some factors to consider when implementing one of these methods into your financial goals.
1. Pay more than the monthly minimum due
Paying the monthly minimum payments may take a long time to pay off the debt. Your outstanding debt will continue to increase as interest charges accrue each day you have an unpaid balance. So, just paying the minimum due each month may not make much of a dent in your overall credit card debt. Consider paying more than your minimum payment in order to bring down your overall credit card debt.
2. Carve out what your budget can afford to pay off credit cards
Assume that you will only make your minimum monthly payments against your credit card balances and then work out the rest of your monthly budget. Once you find out how much additional money you can put towards your credit card debt, you can build a repayment strategy that works.
- Add up all of your monthly bills and money for necessities, including the minimum payments due on all of your cards.
- Determine how much cash you have left over that you can dedicate to debt repayment.
3. List your credit cards' balances and APRs
You should be able to locate each card's APR by looking at your credit card statements. Next to each card's APR, list the card's current balance. By doing this, you may be able to calculate which credit card may rack up the most (and least!) interest over time. This may help you in deciding which debt method might work for you.
4. Select the right repayment strategy
Once armed with your new knowledge of what you owe and what you can afford to put towards debt repayment, you're ready to choose which card to tackle first.
There are three basic strategies:
Snowball method: pay off the smallest balance first
Some financial advisers suggest tackling the smallest balance first, while maintaining the minimum payments on the others.
While this won't reduce the amount of overall interest you will pay against all of your credit cards, it's a great way to build momentum: Once you've paid one card off, you'll be even more excited and determined to pay off the card with the next smallest balance, and so on until you've rid yourself of all credit card balances. The way it works is:
- Identify the card with the lowest balance and add its minimum payment amount to the amount of money you dedicated towards paying off your debt in the steps above (for example: $100) to get a set monthly payment you'll make until the entire balance is paid off.
- Once that card is paid off, you can take that monthly payment and add it to the minimum payment of the 2nd card with the next smallest balance. Add them together to get a new, bigger monthly payment to put toward the second card, and make that payment until its balance is zero.
- Repeat the exercise until all your cards are paid off.
Avalanche method: pay highest APR card first
Paying off your credit card with the highest APR first, and then moving on to the one with the next highest APR, allows you to reduce the amount of interest you will pay throughout the life of your credit cards.
This method will rid you of your balances slightly quicker than the snowball method, but the principle is the same: You calculate a monthly payment in the same fashion; pay off your highest APR credit card, and then add that first card's monthly payment amount to the minimum payment due on the next card in line, to determine its monthly payment amount. Pay that off and repeat, until you've reduced all of your credit card balances to zero.
If you have a good credit score, you might qualify for a balance transfer card, with a low to zero interest promotional period lasting anywhere from 6-18 months.
These are great tools for consolidating all of your credit card debt. The aim is to pay off all of your transferred balances on the new card before the low-to-no interest period closes.
Here are a few things to consider before choosing this strategy:
- Each balance transfer will likely cost a fee (either as a percentage of the amount transferred or as a fee for each transfer).
- APRs increase significantly at the end of the introductory period—which is why it's so important to pay everything off before the period closes.
- Paying off all of your debt in a 6-18 month period might require a hefty monthly payment.
- Opening a new credit card account could impact your credit score. Every new card opening results in a "hard inquiry" of your credit report by the lender, which can be a negative for the score itself.
5. Maintain healthy credit habits
Knowing your monthly budget for credit card payments should help you understand both (1) how credit cards work and (2) the amount of money you could potentially use as savings each month.
Convert credit payments to savings
When you reach a zero balance on all of your credit cards, you can earmark your monthly credit card payment budget for savings: allowing you to build a savings fund that can surpass even your credit limits.
Monitor your credit score and credit card fees before you close a credit account
As you pay off your credit cards, take care to closely monitor them, as even credit card accounts with no balance can accrue annual fees and other fees.
However, keeping your credit account open and using it to pay off purchases can drive your credit score higher, while closing accounts reduces your credit utilization ratio and average age account (two factors in your credit score).
Ideally, as your credit cards are paid off, keep them open if their annual fees and other fees are minimal and if you are not planning on using the card to accumulate debt again. If you do choose to close the account entirely, consider only doing so after you have monitored the balance and your associated credit score for a few months.
Understand your interest
High APRs will multiply what you owe: now that you are working to reduce your credit card debt, be mindful of how often you use your card(s) and commit to paying your balance off each month to prevent interest from accruing. Likewise, if you need to continue using credit, use your lowest APR card for purchases.