Dear Sally,
If I have a sum of $4,000, is it better for me to pay off one card with it or make $500 payments each to multiple cards? All my cards are close to being maxed out. – April
Dear April,
The best way to use $4,000 to pay down credit card debt depends on what is most important to you, and what motivates you to pay down your debt and to keep paying it down until you are debt free.
Financial experts don’t all agree on how you should go about paying down credit card debt. Personal finance expert Dave Ramsey famously teaches the snowball method, which means you pay off the account with the lowest balance first, and then the next, and so forth – regardless of the interest rate on each account. Ramsey’s reasoning is that you receive a psychological boost when you pay off an account. It’s a simple plan, and it also offers the advantage that you soon have fewer payment due dates to worry about.
Other experts say you should pay down the cards with the highest interest rate first. That’s hard to argue with, especially if one interest rate is comparatively high. Mathematically, it’s the correct choice. You will pay down debt faster using the highest-rate-first method.
Another factor to consider, especially if your main concern is your credit score, is lowering your total debt in proportion to your available credit. This is called “credit utilization,” and the lower your credit utilization, the better. (Up to a very low point. You do want to show that you actually use your cards.)
In my opinion, your best bet is to consider all three factors to make the very best use of your $4,000 to pay down debt, save interest expense and improve your credit score. Here’s what I’d do:
If you have any cards with outrageous interest rates, pay them first, and fast! For example, say you owe $4,000 to one card with a 30 percent interest rate, and $10,000 to various cards with interest rates between 10 and 20 percent. Put the entire $4,000 on the card with the high rate. High interest rates can be financially devastating as those interest charges just feed your balance. Once that card is gone, you’ll be able to work on the others.
After you’ve paid off any card with a much higher interest rate than the others, look for any low balance cards you can knock off. For example, if you have a bunch of cards with a low balance on each, consider paying them off next. Not only will you get that psychological boost that Dave Ramsey talks about, but you won’t owe a minimum payment on those cards from now on. That improves your cash flow and simplifies your life.