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.
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:
- $250 at 8 percent interest
- $500 at 4 percent interest
- $225 at 16 percent interest
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.
What works for you
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.