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How to: Your First Card
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What is the best way to pay off credit cards?
Some experts suggest paying off your lowest balance cards first, and then applying your payments for those cards against the next highest balances. While paying off your lowest balance card, you are supposed to pay the minimum payment due. The idea is that you might pay a little bit more interest, but you will gain momentum in paying off your cards.
We've tested several scenarios and the data suggests that it's actually smarter to pay off your highest rate cards first. Here's an example:
You have three cards:
- Card #1 is $4000 at 28% with a minimum payment of $100
- Card #2 is $3000 at 15% with a minimum payment of $75
- Card #3 is $1500 at 9.99% with a minimum payment of $40
If you apply $100 extra to the highest rate card, assuming October 2008 as your starting date, you will pay that card off around December of 2010. That is, you're paying $200 each month on card one, $75 on card two, and $40 on card three.
Once card one is paid off, you apply the $100 extra, the $100 minimum payment for card one, and the $75 minimum payment for card two, to the balance of card two. Each month you're paying $275 on card two and $40 on card three. Card two is paid off in June of 2011.
After card two is paid off, then you apply the total payment for card two to the balance of card three. So, each month you're paying $315. Your balance on card three in June 2011 would be $170.19, so you would pay card three off in July of 2011.
Conversely, paying lower balances off first, using the same cards listed above, pays all cards off in October of 2011. Card three is paid off in September of 2009. Card two is paid off in September of 2010. And, finally, card one is paid off in October of 2011.
Even though you pay off the lower balance cards faster using the lowest balance payoff strategy, all cards are paid off faster using the highest interest payoff strategy. Because your higher interest cards are not allowed to compound as much, or grow interest, your total payoff is cheaper.
If your interest rates between cards are very close, or don't vary by much, you might be better off paying your lowest balance cards off first.
Use our credit card payoff calculator to build a credit card payoff strategy.