You eliminate credit card debt by paying off your credit card balances.
You can make the minimum payments (about 4% of your debt or $10, whichever is larger). But, if you only make the minimum payments, and don't charge anything new, it may take 14 years or more to eliminate your credit card debt. The length of time largely depends on the interest rate you are being charged.
The ideal solution is stop charging things to your cards and pay more than your minimum payment each month to eliminate your credit card debt faster. People typically decide how much extra they can pay beyond the minimum required payments. Then, they pay that amount every month until they have completely eliminated their credit card debt.
So, let's suppose you have four credit cards with the following characteristics:
Card 1: $3,500 balance at a 21% interest rate
Card 2: $2,500 balance at a 19.8% interest rate
Card 3: $4,000 balance at 17.9% interest rate
Card 4: $2,000 balance at 12.9% interest rate
That totals $12,000 of debt. The current minimum payments for these cards (at 4% of the total debt) total $480.
Suppose you can add another $100 to that payment to make a total payment of $580. You will pay $580 each month until you have eliminated your credit card debt.
So, how do you allocate that extra $100 to the four credit cards?
The 3 Methods
There are basically three methods that are suggested:
1) Add all the extra money to the card with the smallest balance.
2) Add all the extra money to the card with the highest interest rate.
3) Add the extra money proportionally to the cards based on their current balance.
Using method 1, you would add the $100 to the payment of Card 4 with the lowest balance. The minimum payment (4% of $2,000) is $80. So, each month you pay $180 on Card 4. This method eliminates Card 4's debt after 11 months. When Card 4 is paid off, you add $180 to Card 2's payment. You then add the amount you were paying for Card 2 to Card 1. Then you pay the entire $580 on Card 3 until it is paid off.
Using method 2, you would add the $100 to the payment of Card 1 with the highest interest rate. The minimum payment (4% of $3,500) is $140. You would pay $240 each month until Card 1 is paid off. When Card 1 is paid off, after 17 months, you add $240 Card 2's payment. You continue to add the amount for a card you paid off to the next card with the highest interest rate.
Method 3 is the most complex. Here you divide up the extra $100 between the four credit cards in proportion to the current balance. In general, the way you determine the amount to add to a payment uses the formula:
(Balance for Card)/(Total Debt)x(Added Amount)
For the first payment, the amount you add to the minimum payment for each card is computed as follows:
Card 1: (3500)/(12000) x $100 = $29.17
Card 2: (2500)/(12000) x $100 = $20.83
Card 3: (4000)/(12000) x $100 = $33.33
Card 4: (2000)/(12000) x $100 = $16.67
Since this is harder than the other methods, you may want to determine the amounts you add to each card only every six months or so.
How Do The Methods Compare?
All three methods will eliminate your credit card debt. So, is one method clearly superior to the other methods?
Here are the results:
Method 1: Add to the smallest debt. This methods will eliminate your credit card debt in 26 months. You will pay a total of $14,618 with $2,618 in interest charges.
Method 2: Add to the highest interest rate. This method will eliminate your credit card debt in 25 months. You will pay a total of $14,471 with $2,471 in interest charges.
Method 3: Allocate proportionally to balance. This method will eliminate you credit card debt in 26 months. You will pay a total of $14,551 with $2,551 in interest charges.
Using method 2 (highest interest) will save you $147 and 1 month over method 1 (lowest balance). So, compared with the $12,000 initial debt, the differences between the methods is relatively minor.
So which method should you use?
If you are interested in a psychological boost by quickly paying off a debt, then pay off the smallest debt first. This will get it out of the way quickly.
If you are interested in paying the absolute least amount of money with the quickest debt elimination, use your excess money to pay off the debt with the highest interest rate first.
If you want to pay off your debts at nearly the same time and don't mind the calculations, allocate your excess payment between all your debts.
The important fact to note is that by adding $100 to your payments you paid off your debt in just over 2 years.
Bob Sherman is the webmaster of http://www.bobshermancredit.com which expains the essential knowlege about credit and debt. The information in this article is taken from him ebook, "How to Free Yourself From Credit Card Debt", available at no charge on his website.
