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Consumers in the U.S. have no problem living on credit.
Consumers on average carry five credit cards with at least $1,000 in debt. Paying off that debt is no easy task for service members, veterans or their spouses.
Focus on high-interest debts when it comes to prioritizing your credit card payments
Compound credit card debt with other forms of debt—car loans or mortgages—and making payments on time becomes a struggle. New research from the University of Michigan’s business school runs counter to common advice, which dictates that you should first pay off small debts with high interest rates before paying off large debts. Take a look at why this advice is not always the best approach to getting out of debt.
When military consumers face several debts, isolating one seems to make sense. But the interest rate of each outstanding debt, not just the amount owed, should be a deciding factor in which balance to first pay off. When consumers mismanage debt by ignoring the balance with the highest interest rate, that balance has the propensity to skyrocket.
The research found that even when participants knew how much interest accrued on a high-interest balance, they failed to focus on their total debt. Instead, they focus on eliminating owed balances instead of the balances themselves.
There is no panacea for debt. However, there are steps military consumers can take to reduce debt. Authors of the University of Michigan research suggest targeting the balance with the highest interest rate even if it’s not the largest amount owed.
Military credit card holders should run the numbers. For example, let’s say you have three balances:
Which one should you pay off first? The balance with the 16 percent interest rate will accrue $36 in interest if you leave the balance at $225 after your next pay period. The other two will accrue $20 each. Focus on the balance with the highest interest rate first.
Research found that consolidating debt, as you can with balance-transfer checks, benefits some credit card users. Consolidating debt forces consumers to look at total debt and shrink that sum.
Not all military credit card users are the same. Examine your total debt, interest rates and income to figure out which approach works best for you, whether it’s paying off several balances simultaneously or targeting one source of debt. Run the numbers on how much interest accrues for each account and how paying them off will lower your overall debt.
Photo courtesy of Images_of_Money under a Creative Commons license on Flickr.
8 Comments
I like the snowball effect better. It allows you to be debt free much quicker than you ever thought possible.
Example: Visa – 1000 ($25 per month), AmEx – 2000 ($50 per month), Mastercard – 3000 ($75 per month)
If you start with the lowest balance and pay as much extra on this one as you can afford, while making the minimum payment on the others, it will be paid off more quickly. The more you can afford to add, the faster it will be paid.
Let’s say you normally pay your minimum payment of $25 on your visa, add say, $100 extra(or more if you can), now your payment is $125. Once you have payed off that one, you add the $125 to the next lowest balance’s payment. Now you are paying $175 per month on the Amex, instead of $50. After that is paid off, add the $175 to the $75 Master card payment and you are paying $250 on that one.
Once the credit cards are all paid off, you can add that $250 to the payment of your next lowest balance loan, i.e. student loans, 2nd mortgage, etc.
You continue this process and the snowball effect allows you to be debt free much quicker. You could be down to nothing but your mortgage payment in 5 years or less, depending on your debt load. Then if you add that “snowball” to your mortgage payment, you will pay your home off much quicker too.
This has worked for many people, including friends of mine and myself. I am a vet and do not make a whole lot of money, if it can work for me, it can work for anyone. The trick is adding as much as you can afford to that first payment and keep at it.
What they are suggesting above is better than the “snowball” effect. It’s not magic its simple math; pay down your highest interest rate balance first, period. That being said, the interest rate calculations in this article are incorrect. A balance of $225 @ 16% APR will accrue roughly $3 after a month.
Solution? Not to get there in the first place. Live within your means. Don’t spend like there is no tomorrow. Stop using the credit card as if it is your money, because it isn’t.
Smart move, if you have a dollar and you want to buy something that cost two dollars. Save your money until you get the two dollars saved, then charge it on a credit card for whatever it was that you wanted to by for two dollars. When the bill comes in, pay off the credit card completely… don’t owe anything. Have a ZERO balance. You’ll build your credit score and keep control of your own money as well as not putting money in other peoples (credit card companies) pockets.
Really good tips, thanks. Also, often a nonprofit credit counseling agency can negotiate lower payments/APRs on credit card accounts, even if the account provider has refused concessions to the cardholder directly. One other small tip: If you can’t afford to make even the minimum payment on all of your credit card accounts, it’s usually best to keep as many accounts current as possible. So start with the smallest minimum account first, and work your way up until you run out of cash.
nice post..i too agree
nice post in this site
When I was getting out of debt, I was dealing w/ “basic” types of debt – credit card, car loans, etc. So, I just used the simple Snowball. Had I, on the other hand, had a bunch of debts, like personal loans or loans from friends and family.. I may have used the “pay off the loan that bothers me the most” method.
Famous Suze Orman suggested that defaulted loans in collection will not have any further effect on your credit because it already downgraded when it happened, that a consumer should focus solely on the current loans make sure they are paid on time. She did not suggest not settling the debt at some point with collection agent, but as far as increasing current credit scores, thats the way to go.
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[...] have to start somewhere if your debt is several thousand dollars. There are different approaches to paying off debt, usually either paying high-interest debt or big balances first. Sit down with all your bills and [...]
[...] reveals that members of the military accrue debt at alarming rates when compared to civilians. This debt can endanger service members’ financial lives (and their jobs) if left [...]