By Peter Dougherty
TODAY’S ‘money’ topic is a practical one: how to pay down credit card debt.
That we should pay down our debt seldom needs explaining – if we have balances on our credit cards, this is something we likely already know.
The most effective strategy for paying down our credit card balance is to focus on one debt.
If we can zero in on a single debt, we’ll see progress as we pay down its outstanding balance. That should encourage us.
We when confront a small hill rather than a mountain, it is also less stressful.
According to the US Consumer Financial Protection Bureau, if we make even one extra payment per year to one of our credit cards we can reduce the interest by hundreds over the life of a balance.
Credit card use is lower in Spain and the UK than in the US and carrying a credit card balance from month to month is less common. Nonetheless, credit cards have some of the highest interest rates of any consumer debt.
The ‘APR’ (Annual Percentage Rate) on card balances in each of these three countries often exceeds 20%.
Even a modest balance can grow rapidly. Perhaps that’s the reason two popular plans to repay our credit card debt have names that refer to snow accumulation: the ‘avalanche’ and the ‘snowball’ effect.
In the ‘avalanche’ method, we rank our credit cards by interest rate, from highest to lowest, and focus on the most expensive debt first. Our current credit card interest rates are shown on our monthly statements.
Next, it’s important that we make minimum payments on all our debts.
Once we’ve done that, we should put any extra money we have toward the debt with the highest interest rate – making multiple payments throughout the month if we can, instead of one on the due date.
Regardless of how big or small that debt is, we’ll save money in interest, which leaves more money for paying down the balance.
Our goal is to pick the card with the highest rate and start paying that one down as fast as we can.
Like an avalanche sliding down a slope, once it’s paid off, we move on to the card with the next highest rate and keep going until all our cards are paid off.
In the ‘snowball’ method, we rank how much debt we owe on each credit card (ignoring interest rate) from the smallest balance to the largest.
Just as with the avalanche plan, we’ll need to make minimum payments on all our debts. After that, we should put any extra money we have toward the smallest debt.
When the smallest debt is paid off, use the amount we were paying on it to the next-smallest debt, and so on.
This method should enable us to build momentum and motivation by paying off our smallest obligations first.
From a strictly numerical standpoint, the avalanche approach works a little bit faster and saves us a little more interest. But either method can help us climb out of debt.
Typically, the snowball method is an easier plan for us to stay committed to because there are more victories early on. But both methods can be effective. Our aim is to pick the one we think will be easiest and get started.
These two plans are commonly mentioned in finance literature as ways to pay down our debt. I personally think a third method, which I’ve named the ‘blizzard’ approach, merits mention as well.
If we encounter a new card offering a 0% introductory APR, we could transfer our high-interest credit card debt to that card.
The goal is to pay off as much debt as possible during the introductory interest period, which is often 12 – 18 months.
We can save a lot of interest during that period. The word of caution, of course, is we need to watch out for balance transfer fees and make sure to pay off the balance before the introductory period ends.
Additionally, it’s helpful if we can stop using our credit cards except for actual emergencies. Digging ourselves out of a pile of credit card debt (or snow) is very difficult if we’re adding to the pile every month.
No matter which approach we may choose – ‘avalanche,’ ‘snowball’ or my self-named ‘blizzard’ – what matters isn’t the weather. It’s that we keep moving through the storm to find a debt balance that’s melted away on the other side.
Peter Dougherty is a Financial Planner at BISSAN Wealth Management in Spain. He holds an MBA in finance from Columbia University in New York and an MS in Spanish Taxation (Máster en Fiscalidad y Tributación) from Nebrija University in Spain. He is a European Financial Planner (EFP) in Spain and is a CERTIFIED FINANCIAL PLANNER™ professional and a Chartered Retirement Planning Counselor® in the United States.
For more information: https://www.financial-planning-in-spain.com
Peter Dougherty
- MBA in finance
- MS in Spanish taxation
- BS in Economics
- European Financial Planner in Spain
- Chartered Retirement Planning Counselor® in U.S.
- Author of two financial planning books
- Certified Financial Planner™ in U.S.
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