61

I'm receiving a $4,000 gift. I'm going to put $1,000 in an account.

Next - with this gift I can pay off a credit card with a 23% APR or I can make a 15% dent in a 26% APR credit card.

Do I pay off the 23% or make the dent in the 26%? Considering both are a high interest rate.

  • 6
    You've got some great answers below, try to build momentum with this, you can get out of debt, and you will love the feeling. Don't give in to any feelings of hopelessness if you hit setbacks, it's not a quick or easy thing, but so worth it. – Hart CO Sep 6 '17 at 14:32
  • 24
    Next step: Refinancing that debt under a lower interest rate. Paying off the $20,000 at minimum payment (about $600/month) will take 60 months. If you can get a loan for $20,000 under 10% interest, that duration drops to less than 40 months. – Chris Sep 6 '17 at 18:52
  • 5
    @PattiReiss Interest usually signals likelihood of repayment - households that get lower interest are rated by the bank as "likely to pay back", so they don't need to be compensated for risk. Someone who manages to get 50k debt on low interest is someone who has a high/steady stream of income anyways - for him the 50k is no life threatening amount. Someone with 50k debt on high interest signals that either i) he/she wasn't able to get a lower interest despite trying, and hence is a risky borrower who has trouble paying back, or ii) someone who didn't bother getting something at a lower.. [1/2] – FooBar Sep 8 '17 at 7:35
  • 5
    rate. Either of which is a red flag. You see, the interest is about more than just the actual additional money to be paid back. [2/2] – FooBar Sep 8 '17 at 7:35
  • 5
    @PattiReiss: "Let's be real"? The first step is admitting you have a problem. Right now, you're paying $5200/year for absolutely nothing. You're correct that many people have more debts. I still have $150000 of debts for example, but I used this money to buy a house though, and I only pay 2.1% APR. – Eric Duminil Sep 8 '17 at 10:55

12 Answers 12

140

Every $1,000 you use to pay off a 26% interest rate card saves you $260 / year.

Every $1,000 you use to pay off a 23% interest rate card saves you $230 / year.

Every $1,000 you put in a savings account earning ~0.5% interest earns you $5 / year.

Having cash on hand is good in case of emergencies, but typically if your debt is on high interest credit cards, you should consider paying off as much of it as possible. In your case you may want to keep only some small amount (maybe $500, maybe $1000, maybe $100) in cash for emergencies.

Paying off your high interest debt should be a top priority for you. You may want to look on this site for help with budgeting, also. Typically, being in debt to credit card companies is a sign of living beyond your means. It costs you a lot of money in the long run.

  • 27
    Thank you, I have been on a very tight budget for 2 months now- cut all subscription services and haven't used a card since July 20th. I know I cannot continue to do what I've done in the past. I also know I didn't accumulate it overnight and it won't disappear overnight either. – Patti Reiss Sep 6 '17 at 14:26
  • 57
    @PattiReiss It looks like this $4k is coming just in time to kickstart your debt repayment right when you're at your most enthusiastic. Great! Don't let this turn into an excuse to 'take it easy' for a few months, use it as motivation to pay everything off even sooner. Good luck! – Grade 'Eh' Bacon Sep 6 '17 at 14:27
  • 18
    @RobertHarvey Paying off the 26% card reduces total interest cost, whereas paying off the 23% card first (because it has a much smaller balance) has a psychological benefit [as well as a possible benefit of having a $0 card where purchases could technically be made and paid off monthly without accruing interest, although given OP's habits she may want to consider whether that option is too tempting to get back into bad habits]. However, I have tried to remain agnostic over which card to pay off, because I think the bigger issue is the lost $ due to the planned $1000 in savings. – Grade 'Eh' Bacon Sep 6 '17 at 17:57
  • 6
    @Grade'Eh'Bacon Paying off the smaller 23% rate card also gives you a chance to just snip it in half and cancel that card, stopping you from further temptation to use it (I've seen people do that and it seems to work for some). – John Hamilton Sep 7 '17 at 7:28
  • 5
    If your line of credit is good, see if you can swap both your debts to a credit card that will balance transfer at 0% for some extended period. By consolidating your debt onto a card that is going to give you a bit of relief from interest payments you can make your payments make more of a dent in the debt. Using this cash you have might enable you to afford the transfer fees (1 to 3% usually) to get these debts onto a cheaper card. Of course, your credit rating would have to be really good to get a card whose limit can afford these debts. See also if your existing lender has any payment plan.. – Caius Jard Sep 7 '17 at 9:58
65

If it were me, I would pay off the 23%er. That is as long as you don't borrow anymore. Please consider "your hair on fire" and get that 26%er paid off as soon as possible.

From my calculations your big CC is sitting at 26% has a balance of 20K. Holy cow girl, what in the world? The goal here is to have that paid off in less than one year. Get another job, work more than you have in your life.

Others may disagree as it is more efficient to pay down the 26%er. However, if you pay it all of within the year the difference only comes to $260. If you gain momentum, which is important in changing your financial life, that $260 will be meaningless. With focus, intensity, and momentum you can get this mess cleaned up sooner than you think.

However, if you are going to continue to rack up credit card debt at these rates, it does not matter what you do.

  • 16
    The 20K estimate looks correct. That means $5200 in interest; the other card incurs $690 in interest. That's indeed emergency territory. – MSalters Sep 6 '17 at 13:35
  • 15
    I do know I need to make a change. Small steps in the past few months have gotten me to this point already. I know it wasn't smart, and I know I need to work at it. I'm trying to look long term and not just make it to the last day of the month anymore. – Patti Reiss Sep 6 '17 at 14:31
  • 22
    @Zibbobz Mathematically, paying off the higher interest debt first is always the fastest way to pay everything off. Of course, as Pete points out, because there is so much less on the 23% card, that there may be a worthwhile 'morale boost' to paying that one off first. – Grade 'Eh' Bacon Sep 6 '17 at 15:05
  • 4
    @PattiReiss you can do it, you can whip this. Budget and follow the process you will get there. This is coming from a reformed over spender. – Pete B. Sep 6 '17 at 15:11
  • 3
    There is also a psychological impact of having that account paid off. Its one less bill every month and one less line item on the budget. – Freiheit Sep 6 '17 at 16:06
34

The difference in interest is not a huge factor in your decision. It's about $2 per month.

Personally I would go ahead and knock one out since it's one less to worry about. Then I would cancel the account and cut that card up so you are not tempted to use it again.

To address the comments...

Cutting up the card is NOT the ultimate solution. The solution is to stop borrowing money... Get on a strict budget, live on less than what you bring home, and throw everything you can at this high-interest debt.

The destroying of the card is partly symbolic - it's a gesture to indicate that you're not going to use credit cards at all, or at least until they can be used responsibly, not paying a DIME of interest. It's analogous to a recovering alcoholic pouring out bottles of booze. Sure you can easily get more, but it's a commitment to changing your attitude and behavior.

Yes leaving the card open will reduce utilization and improve (or not hurt) credit score - but if the goal is to stop borrowing money and pay off the other card, then once that is achieved, your credit score will be significantly improved, and the cancelling of the first card will not matter. The card (really both cards) should never, ever be used again.

  • 39
    The card has a 23% interest rate. The card should be cancelled, destroyed, and never thought of again. Any impact to credit score is meaningless. – D Stanley Sep 6 '17 at 14:27
  • 5
    @PattiReiss Precisely. It's too easy to just "swipe" and not have a grasp on how much you're spending. You need to get to a point where you don't need cards to manange you money effectively. Then you have the option of using them to handle cash flow, but ONLY if you never pay a dime of interest (and even then the use of cards should be minimal). – D Stanley Sep 6 '17 at 14:31
  • 3
    @DStanley Regardless, so long as it doesn't have a balance or annual fee, there is no benefit to cancelling the card, as the immediate drop in credit score due to increase in overall utilization will be relatively large. – Anoplexian Sep 6 '17 at 15:11
  • 4
    @Anoplexian The benefit it it can't be abused again. There's no "benefit" of pouring out bottles of booze unless you're an a alcoholic. (Not saying that the OP is "addicted" to debt or an abuser; just illustrating a point). The downside impact to credit score is minimal compared to the root problem, and will likely go away before the rest of the debt is paid off. – D Stanley Sep 6 '17 at 15:31
  • 5
    If the OP currently has 20K on a 26% credit card, they might find it hard to get a new credit card. That means it might well be sensible to keep the 23% card so that it can be used and paid off in full every month - which means no interest charges on that expenditure. This does require discipline though (which the OP has obviously lacked up till now). – Martin Bonner Sep 6 '17 at 16:42
28

With all due respect to The David, the $1000 is best put against 20%+ debt, no sitting in checking as part of some emergency fund.

I'd agree with the decision to pay off the lower rate card. Why? Because we can do the math, and can see the cost in doing so. Low enough that other factors come in, namely, a freed up card. That card can function as the emergency one in the short term. Long term, once these high rate cards are paid off, you'll build your proper emergency fund, but the cost is too high right now.

The $4000 is a nice start, but the most important thing is to get your budget under control. Only you can decide how much you can cut back, and go after this debt as if it were life or death.

  • Comments are not for extended discussion; this conversation has been moved to chat. (Note: any other comments on this controversial answer should occur in the chat room, linked. Any posted here will be removed with prejudice) – JoeTaxpayer Sep 8 '17 at 2:45
7

I see some merit in the other answers, which are all based on the snowball method. However, I would like to present an alternative approach which would be the optimal way in case you have perfect self-control. (Given your amount of debt, most likely you currently do not have perfect self-control, but we will come to that.)

The first step is to think about what the minimum amount of emergency funds are that you need and to compare this number with your credit card limit. If your limits are such that your credit cards can still cover potential emergency expenses, use all of the 4000$ to repay the debt on the loan with the higher interest rate.

Some answer wrote that

Others may disagree as it is more efficient to pay down the 26%er. However, if you pay it all of within the year the difference only comes to $260.

This is bad advice because you will probably not pay back the loan within one year. Where would you miraculously obtain 20 000$ for that? Thus, paying back the higher interest loan will save you more money than just 260$.

Next, follow @Chris 's advice and refinance your debt under a lower rate. This is much more impactful than choosing the right loan to repay. Make sure to consult with different banks to get the best rate. Reducing your interest rate has utmost priority!

From your accumulated debt we can probably infer that you do not have perfect self-control and will be able to minimize your spending/maximize your debt repayments. Thus, you need to incentivize yourself to follow such behavior. A powerful way to do this is to have a family member or very close friend monitor your purchase and saving behavior. If you cannot control yourself, someone else must. It should rather be a a person you trust than the banks you owe money.

  • Why do you assume OP will be able to obtain a lower rate? 26% could be a reasonable rate for someone who has a lot of debt and maybe a poor credit history. – jwg Sep 7 '17 at 10:24
  • 4
    @jwg Worth finding out at least. According to a comment, OP is able to pay $660 a month on the debt and it looks like two thirds of that is interest. – JollyJoker Sep 7 '17 at 14:33
7

If your credit is good, you should immediately attempt to refinance your high rate credit cards by transferring the balance to credit cards with lower interest rates.You might want to check at your local credit union, credit unions can offer great rates. Use the $4000 to pay off whatever is left on the high rate cards.

If your credit is bad, I suggest you call your credit card company and try to negotiate with them. If they consider you a risk they might settle your account for fraction of what you own if you can send payment immediately. Don't tell them you have money, just tell them your are trying to get your finances under control and see what they can offer you. This will damage your credit score but will get you out of depth much sooner and save you money in the long term. Also keep in mind that if they do settle, they'll close your account. That way, you leverage the $4000 and use it as a tool to get concessions from the bank.

6

When paying off multiple debts there is a protocol that many support. Payoff your debts according to the snowball method.

The snowball method proposes that you make minimum payments on all debts except the smallest one. Payoff the smallest debt as quickly as possible. As smaller debts are paid off, that makes one less minimum payment you need to make, leaving you with more money to put against the next smallest debt.

So in your case, pay off the smaller debt completely, then follow up on the larger one by making regular payments at least equal to the sum of your two current minimum payments. You'll see immediate progress in tackling your debt and have one less minimum to worry about, which can serve as a little safety of it's own if you have a bad month.

As to saving the thousand dollars, that is pragmatic and prudent. It's not financially useful (you won't make any money in a savings account), but having cash on hand for emergencies and various other reasons is an important security for modern living.

As suggested in another answer, you can forgo saving this thousand and put it against debt now, because you will have a freed up credit card. Credit can certainly give you that same security. This is an alternative option, but not all emergencies will take a credit card. You typically can't make rent with your credit card, for example.

Good luck paying your debts and I hope you can soon enjoy the freedom of a debt free life.

6

Patti - I realize, of course, that you pose an either/or question. It seems the question closes the door on other potential solutions.

  • With a score of 760, you are a candidate for a refinancing of some kind. One option is the credit card shuffle, accepting a zero rate intro deal on a balance transfer. This would (a) save you a lot of interest (b) lower your utilization, thus keeping your score high.
  • Other refinance, perhaps better than above, is a consolidation loan through Prosper or Lending Club. A high credit rating customer can see a rate of 6-9%. This would give you a fixed payment and better light at tunnel end.
  • When running a budget so close to break-even, every bit helps. Your garage sale approach is great, wish you well on that. I'd suggest you also consider the side-gig. There are endless possibilities to raise money with a few spare hours a week. The hours can multiply up to 20/mo and even $10/hr will give you $200 to chip away at the debt or build the emergency fund.
  • 1
    I had a friend who got a loan against his life insurance policy, and used that to pay off his credit card debt. But it was a personal one, not through his work, and I have no idea if it was term/life/whatever as I've never dealt with these things. – Joe Sep 9 '17 at 2:25
  • 1
    Term has no 'cash buildup' value, it was a whole life or other variation of insurance. Not recommended, as these are just bad insurance, although for the friend, the forced savings paid off, and to him, the policy "was there when he needed it." – JoeTaxpayer Sep 12 '17 at 11:21
5

I'm going to suggest a slightly different approach. Most answers seem to suggest paying off the lower rate card to clear it. Some answers / comments also talk about emergency funds.

One risk of paying off a card is that the card issuer may choose to reduce your credit limit if they see you as high risk, to prevent you re-spending the money. If you don't trust yourself with the card then this could be a good thing (and remember you're always free to ask for a limit decrease).

But if you want access to emergency funds, then I would suggest paying half onto each card. That way if one card cuts you off, you have a chance of still having access to the other in an emergency.

  • 2
    +1 - when there are already 5+ answers, it's great when the new one has a completely different spin. – JoeTaxpayer Sep 7 '17 at 0:01
4

This is the kind of scenario addressed by Reddit's /r/personalfinance Prime Directive, or "I have $X, what should I do with it?" It follows a fairly linear flowchart for personal spending beginning with a budget and essential costs. The gist of the flowchart is to cover your most immediate costs and risks first, while also maximizing your benefits.

  • Step 0: Budget & Essential bills
  • Step 1: Emergency fund
  • Step 2: Employer matching
  • Step 3: Debt payoff
  • Step 4: Retirement & education
  • Step 5: Max out retirement
  • Step 6: Other goals

It sounds like you would fall somewhere around steps 1 and 3. (Step 2 won't apply since this is not pretax income.) If you don't already have at least $1000 reserved in an emergency fund, that's a great place to start. After that, you'll want to use the rest to pay down your debt. Your credit card debt is very high interest and should be treated as a financial emergency. Besides the balance of your gift, you may want to throw whatever other funds you have saved beyond one month's expenses at this problem.

As far as which card, since you have multiple debts you're faced with the classic choice of which payoff method to use: snowball (lowest balance first) or avalanche (highest interest rate first). Avalanche is more financially optimal but less immediately gratifying. Personally, since your 26% APR debt is so large and so high interest, I would recommend focusing every available penny on that card until it is paid off, and then never use it again. Again, per the flowchart, that means using everything left over after steps 0-2 are fulfilled.

  • 11
    I am a huge fan of "Grab the company match" but if OP doesnt have a plan to kill this debt, 26% interest wipes out a dollar for dollar match in 3-4 years. OP doesn't state the long term plan to kill all this debt. – JoeTaxpayer Sep 6 '17 at 15:23
  • 19
    Hi as the OP - I bring home $2k a month. I have living expenses of 1076 ... following the 50/30/20 plan - I'm almost at target! My debt payments a month equal 660 - which leaves me about 250 for groceries- gas- light bulbs - my consumables. I've worked the last 7 weeks very very hard to stay within that $250. My current goal is not overdraft at the end of this month. I'd like to give an extra $5.00. Somewhere by October. I have submitted my resume to two PT jobs and have some garage items posted on letgo. I am working at this. – Patti Reiss Sep 6 '17 at 15:53
  • 3
    @PattiReiss I know nothing about personal finance that would be useful to you, but I would just like to wish you the best of luck. You can do this :) – Alexander Sep 7 '17 at 4:08
  • 6
    @PattiReiss you seem to know exactly what your income is and what your spendings are. You're definitely on the right track! – Stephan Bijzitter Sep 8 '17 at 11:01
  • @PattiReiss If those two PT jobs don't fall through and you can swing it, consider the gig economy like Uber, Lyft, Doordash if those companies are available where you live. Keep in mind it's more of a crutch as you don't pay taxes on the earnings so down the road IRS will ask you to pay it. – HarrisonT Sep 14 '17 at 7:35
2

If we're including psychological considerations, then the question becomes much more complicated: will having a higher available credit increase the temptation to spend? Will eliminating 100% of a small debt provide more positive reinforcement than paying off 15% of a larger debt? Etc.

If we're looking at the pure financial impact, the question is simpler. The only advantage I see to prioritizing the lower interest card is the float: when you buy something on a credit card, interest is often calculated for that purchase starting at the beginning of the next billing cycle, rather than immediately from the purchase date. I'm not clear on what policies credit card companies have on giving float for credit cards with a carried balance, so you should look into what your card's policy is.

Other than than, paying off the higher interest rate card is better than paying off the lower interest rate. On top of that, you should look into whether you qualify for any of the following options (presented from best to worst):

  1. Get a new card with an 0% introductory rate and 0% transfer rate.
  2. Get a new card with an 0% introductory rate.
  3. Refinance through something other than a credit card (home equity, car loan, personal loan, etc.) Even a 10% loan would be better than what you have now.
  4. Transfer the balance to a new card with a rate below 20%.
  5. Negotiate with your credit card companies. Think of it this way: no matter what, you're going to be paying a bunch of interest. See if you can get them to compete to be the one getting that money. If you pay $4000 towards the high interest card, they're losing $830 in interest per year, and that's not including compounding. They could very well be willing to lower your rate to keep that from happening, especially with the threat of one of the other options I've presented.
  6. Transfer your balance from the high interest card to the low(er) interest rate one. There's usually a 3% transfer fee, but after a year you'll save more than that in interest. You can also try negotiating with your credit card company regarding reducing or waiving the fee (again, make them compete for your business).
0

I like the answers others gave, if it's some substantial debt you definitely could go the bankruptcy route but it damages your future, also it's morally unethical to borrow all that money and not intend to pay.

Second, if you can pay off the entire balance and clear out the 23% interest than I'd do that first. One less bill to concern yourself with.

Now let's say you've been making $100 payments monthly on each card (my assumption for this examples sale) now instead of paying $100 to the remaining cards balance each month and saving the other $100, pay $200 against the remaining credit cards balance. By not taking home any money this way you are tackling the liability that is costing you money every month.

Unless you have a great investment opportunity on that remaining $1000 or haven't created much of an emergency fund yet, I'd consider putting more of that money towards the debt.

Gaining 0.01% on savings interest still means you're eating 25.99% in debt monthly.

If you're able to I'd venture out to open a zero interest card and do a balance transfer over to that new card, there will be a minimal transfer fee but you may get some cash back out of it and also that zero interest for a year would help hold off more interest accruing while you're tackling the balance.

  • It has nothing to do with ethics, its illegal to borrow money that you don't intend to pay, that's fraud. There are plenty of legitimate bankruptcies and money is lent at a cost that takes in to account default and charge-off risk. The size of the debt is not the qualifier for bankruptcy, the debt needs to be insurmountable relative to income and projected future income. – quid Sep 13 '17 at 23:58
  • I'm assuming OP didn't intentionally borrow it to declare bankruptcy. But if they're not able to pay than that might be there only way out. – HarrisonT Sep 14 '17 at 0:00
  • when I read if it's some substantial debt you definitely could go the bankruptcy route but it damages your future, also it's morally unethical to borrow all that money and not intend to pay. seems like an assumption this money was borrowed without the intent to pay. – quid Sep 14 '17 at 0:04
  • I see your assumption. – HarrisonT Sep 14 '17 at 0:06

protected by Ganesh Sittampalam Sep 6 '17 at 16:03

Thank you for your interest in this question. Because it has attracted low-quality or spam answers that had to be removed, posting an answer now requires 10 reputation on this site (the association bonus does not count).

Would you like to answer one of these unanswered questions instead?

Not the answer you're looking for? Browse other questions tagged or ask your own question.