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If you have credit card debt, start with this first. Breathe deeply. You’re not alone.
In this article, we’ll cover the two popular ways to tackle credit card debt: the snowball and the debt avalanche. They boil down to two schools of thought. One relies on psychology as a motivator (debt snowball) and the other focuses solely on numbers (debt avalanche). There are pros and cons to both approaches, as you will see.
To begin with, however, we must first consider the dangers of making only the minimum payment on a credit card.
Minimum payments by credit card
Credit card issuers use different formulas to determine the minimum monthly payment. In general, the minimum payment will be about 1 – 3% of the unpaid balance. As a result, the minimum payment on $ 10,000 of credit card debt will only be a few hundred dollars.
This relatively low payout is attractive to many. A recent study found that 29% of US credit card accounts regularly make minimum or near minimum payments. This creates a big problem.
Just making the minimum payment on a credit card is expensive. A balance of $ 10,000 at 18% interest with a minimum payment of 2% generates a minimum monthly payment of only $ 200. Make only the minimum payment, however, and it will take over 30 years and cost over $ 35,000 to pay off the debt, according to this. Discount rate calculator.
We can do much better by using the snowball or the avalanche methods.
The Debt Snowball
With the debt snowball, you list all of your debts based on the outstanding balance. You make the minimum payment on each card. Then you pay the extra money you have on the card with the smaller balance. Most importantly, you don’t factor in the interest rate of each card. Instead, you just focus on the outstanding balance.
The theory is that by focusing on the smallest balance first, you’ll pay it off quickly. This will motivate you to keep paying off your debt. Once the smaller debt is paid off, you direct the money you paid on that debt to the card with the next smaller balance. This process continues until all of your credit card debt is paid off.
Depending on your personality, paying off a small amount of debt before you tackle larger bills can be a big boost. For people who are emotional about their finances, this can be a great strategy.
The avalanche of debts
With the avalanche of debt, the focus shifts from the smallest balance to the highest interest rate. Any additional funds above the minimum payment go to the card with the highest interest rate. Once paid in full, the money is then directed to the card with the next highest interest rate.
From a financial standpoint, paying off your higher interest rate balance first is the safest course of action. Obviously, you should continue to make minimum payments on all credit card while you are doing this, but you need to prioritize your higher interest rate debt to zero.
The result is that you get out of debt paying as little interest as possible. However, it can also mean that it takes a long time to eliminate that first debt.
Debt Snowball Against Avalanche
It could be that your highest balance card is also the one with the lowest interest rate, which we say, you are in luck! In some cases, there may not be much difference between the avalanche method and the snowball method. Use this free avalanche / snowball calculator to see if there is a big difference between these payment strategies and decide which one is best for you.
If you’re drowning in high interest rates
If you are committed to paying monthly installments but are still drowning in credit card debt due to the high interest rates, there are additional options. These two elements by no means wipe out debt and also come with their own setbacks. However, they could help you with high interest rates if the snowball or avalanche method doesn’t work fast enough.
Consolidate credit card debt
If the avalanche and snowball method makes you spin around and keep paying high interest rates on multiple cards, you can consolidate your credit card debt with a credit card consolidation loan or a small personal loan.
This can be a great way to cover credit card debt. Your debt is consolidated into an unsecured personal loan which is then repayable in three to seven years. While you still have the same total amount of debt, you probably won’t pay outrageous interest rates along the way.
As all cases are different, use this calculator to see if a small personal loan is the right way for you. Another benefit of a small personal loan is that if you qualify, it can help increase your credit score.
Balance transfer card
A balance transfer card gives you the option of 0% interest rate for a fixed term, usually between six and 21 months. You can transfer your high interest credit card debt to this card, which means you’ll have a break from interest rates and be more able to manage your balance.
One caveat is that these cards generally require a high credit score. If you’ve neglected your monthly payments or damaged your credit, this may not be an available option.