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The best way to manage your credit cards is to pay off any charges you make in any given month. In other words, you should only use your credit card if you have the cash to pay for the purchase.
You’ve probably heard this advice before. But if you currently have an outstanding balance on your credit cards, you are far from alone.
There is no point in fighting if your credit card balances have increased more than you expected. Everybody makes mistakes. But it’s important to recognize that debt is costing you money and come up with a plan to improve your situation.
The good news is that there are several approaches you can take to eliminate your credit card debt. Below is an overview of several common credit card repayment strategies, along with extensive research to help you decide which option is best for you.
A glance at the numbers
Month-to-month revolving credit card debt is expensive and can hurt your credit score. Yet, it’s a common financial mistake that a lot of people make (or, at least, have made at some point in the past).
Before we dive into credit card repayment strategies, here are some key statistics to help you compare your debt to that of others.
- 75% of credit card holders run a balance on their credit card accounts.
- $ 5,315 is the amount the average American owes in credit card debt.
- Americans pay only the minimum payment, or almost, on 29% of credit card accounts.
Strategy # 1: The Debt Snowball
How The Debt Snowball Method Works
The Debt Snowball is a credit card repayment strategy that requires you to list your outstanding credit card balances in a particular order. At the top of your debt list, you’ll want to insert the account with the lowest balance. Then you will rank the remaining accounts from smallest to largest, based on the balances you owe.
Here’s an example of what the debt snowball looks like on paper.
Once you’ve set the payment order for your accounts, you’ll continue to make at least the minimum payment on every credit card other than the first payment location. (Paying the minimum payment helps you avoid credit card defaults.) But you pay as much as possible for the account with the lowest balance in an effort to pay it off first. Finally, after paying off the card to the smallest balance, move to the next account on your list, rinse, and repeat.
What the research says
A number of finance and credit experts believe that paying off the smallest debt first is the best way for consumers to pay off their credit card debt. Here is a look at some research that supports this theory.
- A study by the Boston School of Business finds that the repayment strategy you choose can have an influence on the amount of money you apply to debt elimination. Consumers in the study who paid off their bills one by one paid off their debt 15% faster than those who paid off their debts in equal amounts. Bottom Line: Small wins can keep you motivated.
- Experian gives an example of how the debt snowball method can save you money on interest. In the scenario, a consumer who has nearly $ 19,000 in debt could use the debt snowball approach to pay $ 4,300 less in interest, even without making additional payments above the total amount owed when. ‘he created the original debt repayment list. The secret is to apply the extra money you free up when you pay off your first debt to the next highest balance (and so on).
- myFICO points out that the debt snowball method could also help you reduce the credit utilization rates on your individual credit card accounts faster than the avalanche of debt. Why is this point significant? Anytime you lower the balance / limit ratio on a credit card (even an account with a small balance), there is a chance that your credit score will improve. And a higher credit score can save you money in ways that aren’t always immediately apparent.
Strategy # 2: Debt avalanche
How the debt avalanche method works
Debt avalanche is another credit card repayment strategy that requires you to list your credit card balances in a particular order. With this approach, however, you base your debt repayment sequence on your high to low interest rate.
Here is a hypothetical example of a debt avalanche plan.
As with the debt snowball, you make the minimum payment on all of your accounts except the credit card in the first payment window. (This is the card with the highest APR with the debt avalanche approaching.) Then you pay as much as you can each month until you clear the card balance first. at the highest APR.
Once you’ve paid off your account at the highest APR, turn over the money you paid on that debt each month and apply it to your card with the second highest APR. Repeat this process until all of your accounts have zero balances.
What the research says
If you look at your debt from a purely mathematical perspective, debt avalanche seems like the best approach. Many financial experts agree with this assumption. After all, tackling your highest interest rates first should save you more money in most situations.
- A study by James Madison University has found that if someone’s goal is to simply pay off their debt as quickly as possible, the debt avalanche is the ideal choice.
- The National Bureau of Economic Research also published a study which found that in the case of interest rates of 17% and above, study participants would pay less following the elimination of conventional debt, i.e. the avalanche of debt.
However, there is a “but” that appears in debt research. If the person trying to eliminate debt has bad financial habits or lacks motivation, snowballing debt may actually be the best debt repayment strategy.
- The National Bureau of Economic Research The above study found that the psychological benefits of small wins with the debt snowball method could be powerful enough to outweigh small changes in interest rates.
- A Kellogg School of Management A study found that consumers who owe large credit card balances are more likely to eliminate all of their debt when using the snowball method because of its psychological benefits.
Strategy # 3: Debt Consolidation
How Debt Consolidation Works
A third method that you can use to pay off your credit card debt is debt consolidation. Debt consolidation is when you use a new loan or a new credit card to pay off existing balances you owe. The goal of debt consolidation is to get new financing with a lower interest rate in order to pay off your debt faster and save money.
The three main types of debt consolidation are:
With any type of debt consolidation, it is important to make sure that you stop overspending on your credit cards. If you pay off your cards with new funding, but again accumulate a balance on the original accounts, you could be setting yourself up for serious financial and credit problems down the road.
Also, if you are planning to apply for new financing, it is better if your credit rating is good or excellent. It is possible to qualify for debt consolidation financing with bad credit, but you might not qualify for an interest rate that makes the process worthwhile.
What the research says
If you can avoid overspending, many financial experts agree that debt consolidation could help you pay off your credit card debt faster. Research, on the other hand, is a bit of a mixed bag.
- A University of Michigan Research has found that debt consolidation can focus a consumer’s attention on what matters most: reducing their total debt as quickly as possible.
- Boston Business School However, the study mentioned above found that unless you can get a considerably lower interest rate, combining debt can be daunting and slow down the process of debt elimination because it takes away the burden of debt. motivation for small victories.
Which credit card repayment strategy is right for you?
Aside from research, it’s important to note that every debt situation is different, and so is every debtor. You know yourself better than anyone. So you are in the best position to decide which credit card repayment strategy is right for you.
If you’re having a hard time making up your mind, here are some questions you might want to ask yourself.
- What’s most important to you: saving as much money as possible or getting some debts off your list?
- Is your credit rating in good condition so that you are likely to qualify for debt consolidation financing?
- Do you think you could mentally benefit from eliminating small debts faster?
- Are you planning to apply for new funding in the near future? (If so, lowering your credit utilization rate across multiple accounts could raise your credit score faster than the debt avalanche approaches.)
- Do you think you have the discipline to stay motivated if you focus on the account with the higher interest rate first, even though it will take longer to pay off due to a larger balance?
Above all, keep in mind that there really is no bad debt elimination strategy. As long as you lower your high interest credit card balances and avoid new debt, you are stepping into a stronger financial future.