Deciding which credit card to pay off first depends on the interest rates and status of your accounts, as well as your primary objective. In most cases, your primary goal is usually to get out of debt as fast as possible. This helps minimize interest charges, so you can save money as you become debt-free. However, if money is tight and you’re struggling to gain momentum, you may need a different strategy.
Method 1: Prioritizing credit cards by interest rate
The most common way to decide which credit card to pay off first is to arrange your accounts by APR. The idea is to pay off the debts with the highest interest rates first because those cost you more money. So, if you have three cards that have APR of 15%, 20%, and 22% then you’d pay off the balance at 22% first.
You still make payments every month on the other two cards, but you only pay the minimum required payment. Then you devote all your extra cash to making the largest payment possible on the card with the highest APR. This keeps all your accounts current, so you don’t damage your credit history while focusing your efforts on repaying one debt at a time.
By paying off the highest APR debt first, you will save money as you work to get out of debt. That’s because higher APR means higher accrued monthly interest charges.
The challenge of prioritizing credit cards by APR
Although prioritizing balances based on APR makes sense on paper, it doesn’t always work in practice. If the credit cards with the highest APR also have your highest balances, it can get tough to stay motivated as you eliminate debt. In this case, it may make more sense to take a different tactic that can help you build momentum to tackle these largest debts.
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Method 2: Prioritizing balances from lowest to highest
Another option for how to prioritize your balances for repayment is to start with the lowest balances first. This helps you do two things:
- It’s motivating to pay off balances and eliminate bills, giving the momentum you need to tackle your largest debts.
- Knocking out bills frees up cash flow, giving you more paying power to eliminate your largest balances faster.
As with the first method, you still make the minimum payments on all your other bills. But you focus all your extra cash on paying off the lowest balance with the largest payments possible. If you can pay off one or two low balances that you can, you eliminate those bills and free up cash flow for eliminating the higher balances down the road.
Eliminating balances is also highly motivating. You feel like you’re making progress, so it’s easier to stick with things like cutting back in your budget. Starting with your largest balances first can get exhausting. And much like dieting, if you can’t stick to a plan, then it’s not going to get you the results you want, even if it’s the best thing for you.
Combining the two methods
If you’re short on cash for eliminating debt, but you still want to eliminate your debt efficiently, then you may decide to combine the two methods. First, pay off a few low balances to generate cash flow. But then once you generate enough cash to make larger extra payments, switch to prioritizing your debts by APR.
Making exceptions based on the status of your accounts
There are a few special considerations that you may need to make, depending on the status of your accounts. These accounts would take priority over arranging your debts for payoff using the methods above.
Catch up delinquent credit card accounts first
If you have any credit cards that are delinquent, then your first priority needs to be getting those accounts current. Delinquent accounts refer to any balance that is more than 30 days past due, but that hasn’t been charged off. In other words, accounts that are behind but that can still be saved from collections.
Once an account is more than 60 days past due, the credit card company will report the delinquency to the credit bureaus. Every month that passes before you bring the account current will; ding your credit. The damage to your credit score stacks up quickly.
So, your first priority needs to be bringing delinquent accounts current. This means paying the minimums on all your other balances to keep them current. Then you focus all your cash on catching up with the delinquent account. Review your budget and cut back as many discretionary expenses (wants) as you can afford to give up. This will maximize the cash flow you have available to bring those delinquent accounts back to a current status.
Pay off deferred interest balances before the introductory period ends
Another balance you want to prioritize ahead of the others is one that has a deferred interest period. This is where the interest is held for a certain period of time after you first open the account. They’re those offers of, “Pay no interest until June of 2020.”
The problem with deferred interest comes if you don’t pay off your balance in full before the introductory period ends. If you have any balance left at the end of a deferred interest period, then you pay interest charges on the full amount.
Say you buy a $400 TV with a store credit card. You pay $25 on time each month, but by the end of the one-year period, you still owe $100. With a deferred interest card, interest would be adding up throughout the year, and place an extra $65 on top of the amount you still owe.Source: Consumer Financial Protection Bureau
This means that balances on deferred interest credit cards should take priority. Your priority must be to pay off the balance in full before the deferred interest period ends.
Eliminate transferred balances during 0% APR period
Another credit card balance that you want to pay off quickly because it offers an introductory rate is a balance transfer credit card. Balance transfer cards allow you to move balances from your existing cards to one with a lower interest rate. Many of these cards offer a 0% APR introductory period. You pay no interest for anywhere from six to eighteen months, depending on your credit score. Interest doesn’t defer, but once the introductory period ends the normal interest rate on balance transfers kicks in.
If you have a balance transfer card that’s still in the 0% APR period, focus on paying off that balance quickly. Ideally, you want to eliminate the transferred balance in full before the 0% APR period ends.
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Article last modified on November 3, 2022. Published by Debt.com, LLC