With the new year, one of your goals may be to reduce your debt. Credit card debt is considered one of the worst, as interest rates on cards can be as high as 28%. Regardless of the type of debt you have, be sure you understand the terms of your debts before starting a debt payoff strategy.
Generally, you are required to make minimum payments. Failure to make minimum payments will often trigger penalties, increase your interest rates, and may cause you to default. By making only the minimum payment, you may also pay several thousands in interest over the life of the loan. If you have a credit card with a balance of $4,000 with a 15.4% interest rate, and only make a minimum monthly payment of $85, your balance will be paid off in six years and one month. You will have paid $2,173.60 in interest—that is more than half of what you originally owed.
Paying more than your minimum payment will reduce the time it will take to pay off the debt in addition to reducing the interest you pay. If you made monthly payments of $125 on the debt above, you would pay off the debt in three and a half years, and pay only $1,183.47 in interest.
If you have multiple debt balances, you can optimize payments by paying the minimum payment on all the debts except the one with the lowest balance or the one with the highest interest rate. You then concentrate additional funds after minimum payments on the one debt. By concentrating on the lowest balance, you will see your progress faster. By concentrating on your debt with the higher interest rate, you can significantly reduce the time it will take to pay off the debt and save money in interest payments.
Pay Off Highest Interest Rate Debts First
For example, consider two debts at $5,000 each; one at a 12% interest rate and the other at 18.5%. Both debts require a minimum monthly payment of $100. If you pay only the monthly payment, it will take you eight years and one month to pay off the debt with $6,596.40 paid in interest. If you were to pay an extra $100 each month to the 18.5% interest rate debt, your total pay off time for the two balances would be reduced to five years and 10 months, and the interest paid would be reduced to $3,330.35.
Pay Off Lowest Balance First
Now, you may wonder why we would suggest you would pay on the lowest balance credit card first. The answer is simple: positive reinforcement. People who try to pull themselves out of credit card debt usually want to see results fast. As with any habit-altering task, your chance of quitting before you are completely out of debt is greatly increased if you don’t see something good happening within a short period of time. Lack of results could make you feel helpless, like you are destined to be in debt. However, if you rearrange your payments and pay the lowest balance off first, you will see the positive results quicker. In short, seeing that credit card go from a $500 balance to zero in a relatively short amount of time can reinforce your desire to pay off the rest of your credit card balances.
At Henssler Financial, we believe you should Live Ready. That means having your debt under control so you can weather any unexpected financial challenges life might bring. If you have questions, contact the experts at Henssler Financial: 770-429-9166 or experts@henssler.com.