Debt Payoff Methods
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According to data from 2022, the average American had $5,910 in credit card debt. With fears of a looming recession and still-above-average inflation, everyday consumers are struggling to manage their expenses without taking on additional debt.
And unfortunately, as the Federal Reserve has increased interest rates to tamp down inflation, rates on credit cards have also increased. The current average is around 20% APR, which means consumers are paying higher rates on those balances.
If you have recently amassed credit card debt that you want to eliminate, keep reading to understand how to pay off your debt.
The Crippling Effects of Debt
When you have debt, there’s more than just the stress of monthly payments to worry about. In fact, being in debt can have an extremely negative impact on your credit score.
Here’s how. There are two main factors that have the biggest impact on your credit report: your on-time payment history and your credit utilization ratio. Your credit utilization ratio, which makes up 30% of your credit score, is determined by your current credit balance divided by your total credit limit.
For example, let’s say you have an $8,000 balance on your credit card with a $12,000 limit. In this case, your credit utilization ratio is 66.67%. Credit bureaus will ding you if your credit utilization ratio is above 30%.
Many consumers with credit card debt also have a high credit utilization percentage, which will likely lower their credit score. And if you have a low credit score, it will be harder to qualify for a lower interest rate on a personal loan or a 0% APR balance transfer card.
Is it Worth Paying Off Credit Card Debt?
When it comes to paying off debt, credit card debt is the most important debt to focus on. Credit cards typically have higher interest rates compared to personal loans, student loans, auto loans and mortgages. In general, only payday and title loans have higher interest rates than credit cards.
If you have credit card debt, you should try to pay it down as soon as possible. Plus, paying down your credit cards will improve your credit utilization ratio, which will improve your credit score.
Help With Your Debt
Popular Methods to Pay Off Debt
Before you begin your debt payoff plan, take some time to review the various strategies you can employ:
Consolidation
Consolidation takes multiple loans or credit card balances and merges them into one loan or credit card. For example, if you have credit card debt on three separate cards and take out a personal loan to pay off all three cards, that’s an example of consolidation.
Most consumers choose to consolidate their debt to get a lower interest rate, which can help them repay their debt faster. Personal loans may have lower interest rates than credit cards, especially if you have excellent credit. Plus, personal loans have fixed interest rates so the monthly payment will never change.
Balance Transfer
Most credit card issuers let you transfer a balance from one credit card to another. The best time to do this is if you qualify for a new credit card with 0% APR on balance transfers. These promotions often last between 6 and 21 months, depending on the card.
You may have to transfer the balance within a certain timeframe to qualify for the 0% APR, usually within the first few months of having the new card.
Balance transfers may have fees around 3% of the total balance. However, this cost can be offset if you can pay off the debt quickly and is typically less than what you would pay in interest over the following few months without the transfer. You generally need to have good or excellent credit to qualify for one of these balance transfer offers.
Avalanche
The avalanche method says that you should pay off the specific loan or credit card with the highest interest rate first. Utilizing this method will help you save the most on total interest.
To get started, write down all of your debts and their interest rates. Figure out how much extra you can pay each month and add that figure to the loan or credit card with the highest interest rate. Once that debt has been repaid, you can take that monthly payment and put it toward the next highest interest rate debt.
Snowball
Popularized by personal finance personality Dave Ramsey, the snowball method says you should put any extra dollars to the loan or credit card with the lowest balance, not the highest interest rate. This will help you knock out individual loans and credit cards faster, which can spur your debt payoff journey.
When you completely pay off the smallest balance, you’ll take the monthly payment you were making and apply it to the next smallest balance. Keep doing this until all your debt is paid off.
Even though the snowball method may not maximize your interest savings, research from Harvard University has found that it can motivate consumers more than other methods. Because you’ll be able to reduce the number of loans or credit card balances faster, you may feel like you’re making more progress. This is essential to staying on the debt payoff journey and not falling off the wagon.
Other Types of Debt
If you’re having trouble qualifying for a debt consolidation loan or a 0% APR credit card, contact your lender and ask them if you are eligible for any other special programs or other forms of assistance.
For example, federal student loans come with a variety of income-driven repayment plans, which may lower your monthly bill. You can use the difference to pay off other loans with higher interest rates. Borrowers with federal student loans may also be eligible for loan forgiveness programs that can knock out their debt early.
