Credit cards are hard to pay off, and if you’re like most of the US population, you probably have some credit debt to your name.
In fact, the typical American has four credit cards and an average credit card balance of nearly $6,200. That’s about 20 percent more credit card debt than a decade ago. Paying off credit card debt is one of the most difficult things to do because the average interest rates range from 15.58 percent to 22.83 percent.
So say you have a credit card balance of $10,000 and a 20 percent APR. You’d pay about $2,215 in interest every year you hold that debt.
Let’s look at some strategies to pay off that balance and avoid those pesky interest rates.
How to pay off credit card debt
If you’ve been following our budgeting tips, you already know that a standard budget sets aside 20 percent of your income to pay off debts or save money. If you have credit card debt, it’s smart to prioritize paying down these balances so you don’t keep losing money in interest charges.
Here are five ways you can do just that.
1. Try the debt snowball method
Best if: You need a little momentum
The debt snowball method is a budgeting and debt repayment method where you pay off the smallest debts first. The idea is that you gain momentum and feel good about getting something to a zero balance before focusing on the next larger debt.
In this method, you pay the minimum required payment on all credit cards except the one with the smallest balance. You pay down that one with both principal and interest payments.
This method was made popular by Dave Ramsey, but Debt.org notes you may pay more in the long run if you use this budgeting method. That’s because you may be making minimum payments on cards that generate the most interest.
Let’s do the math: if two cards have the same APR of 20 percent, the one with the bigger balance is costing you more in interest. Assume you are paying off the $1,000 balance versus the $10,000. The smaller card has $212.50 in yearly interest while the larger one costs you $2,215 in interest every year.
That said, this method is praised for its psychological advantage: it feels good to pay a balance off. That can help inspire folks to tackle the bigger debts.
2. Use the debt avalanche method
Best if: You have high-interest credit cards
The concept is simple: pay off the most expensive debts first. The debt avalanche method prioritizes paying off the credit card with the highest interest rate regardless of its balance. Once that card is paid off, you focus your efforts on the next debt with the highest interest.
Unlike the debt snowball method which pays the smallest debt first, the debt avalanche makes minimum payments on all cards except the one with the highest interest rate. You’ll pay the interest plus principal on this card every month until it’s paid off.
This is the right route for you if you have high-interest rates that are eating up your minimum payments each month.
3. Transfer your balance
Best if: You can pay off the debt during the zero-interest promotional period
One way to pay down credit card debt is to get the balances transferred to a new card with a lower interest rate. Many cards have an introductory zero interest rate, usually for a year, when you transfer your balance. This means every payment goes toward the principal balance until the APR kicks in.
For this method to work, don’t use the original card anymore. If you have more than one card, continue to pay monthly minimum payments while you pay down the card with zero interest.
Before you transfer a balance to a new credit card, check transfer fees and the APR once the promotional period ends. This option often only makes sense if you can pay off the balance during the promotional period.
For example, if you have $10,000 in credit card debt that you are transferring over to a zero-interest promotional card, there may be a 3 percent to 5 percent transfer fee. This could add up to $500 to your total debt just by transferring the balance. Make sure you’re aware of all fees and costs before transferring your balance.
4. Apply for a home equity line of credit
Best If: You Want to Consolidate High-Interest Debt
One method to get rid of credit card debt is to transfer the balance to a home equity line of credit. This method requires discipline: you don’t want to overspend when you have access to a large line of credit. The process is simple: use the checks provided by the credit line to pay off your existing credit card balances.
Home equity lines of credit typically have interest rates much lower than credit cards, which decreases the cost of the debt. Another advantage is that they charge simple interest rather than compound interest. This reduces the amount of interest you pay over time.
Keep in mind that these rates are usually variable and can go up.
5. Explore a cash-out refinance
Best If: You Have Enough Equity to Cover the Debt
If you are planning to refinance your mortgage to take advantage of historically low-interest rates, you may want to consider rolling your credit card debt into the refinance. You’ll need to have enough equity in your home to account for the new debt, but this option helps you to stop paying 15 percent interest rates – and you even get a tax deduction on interest payments.
Talk to your lender about consolidating your debt into your refinance. They’ll obtain copies of the credit card debt and run a detailed analysis of when your break-even point will be. When the loan funds, the lender will send a check to the credit card company to pay it off. While you are in escrow, you’ll want to continue to make minimum payments on the debt.
One of the good things about consolidation is you only have one bill to pay monthly. But be sure to maintain discipline with the credit cards and not rack up a bunch of new debt when you see the balances at zero.
A note on budgeting for debt payments
No matter what method of paying down credit card debt you choose, you’ll need a budget that allows you to make payments beyond the monthly minimum. Most budget systems work on the 50/20/30 budget model: 50 percent for needs, 30 percent for discretionary spending, and 20 percent for savings and debts.
Factor this 20 percent into your budget to make sure you have enough money every month to pay toward the principal in addition to the interest. Start thinking about debt as a numbers game that you will win at.
Write your debts down. Include the balance and the interest rate so you can clearly see what each credit card balance is costing you. From there, choose one of the methods above so you can pay the debt off and start living a debt-free life.
Tips for paying off credit cards in full
Accumulating debt can happen in a matter of minutes, but paying it off often requires months, if not years, of discipline. Regardless of what method you choose to pay off your debt, use these tools as a starting point and remember to:
- Stick to the plan. Consistently paying down your balance is the only way to pay off your debt in a timely way.
- Freeze your credit cards while you pay them off. This prevents you from using them and adding to your balance.
- Put windfalls to work. Got a big tax return? A stipend? Sold some collectibles on eBay? Put that unexpected cash toward your debt.
Keep in mind that credit history – how long you’ve had your credit cards – is a positive indicator for credit scores. This means you might not want to cancel your cards altogether after you pay them off.
Paying down debt will have a positive impact on your credit score – and in some states, that can lead to lower home insurance premiums.
