10 January 2007


How to Pay Off Revolving (Revolting) Credit

So your credit card bills are driving you whack. How to finish them off? This approach is probably as old as the ages, but it's worth repeating.

  1. Quit digging. Get on a cash basis where you make your ordinary and extraordinary purchases without increasing your revolving debt load.
  2. When a credit card offer allows you to transfer balances at a lower interest rate to it -- without a time limit (and that's harder to come by these days) -- snarf it up. If you won't be able to wipe out an existing balance by transfer, make sure the increase in the minimum monthly payment doesn't increment your total monthly payment above what you want to afford.
  3. Figure out how much you want to reduce your debt by each month, when you want to be free of revolving credit, etc. Say you owe $24K on credit cards and want to be free of revolving debt in four years. That's $6K per year you want to pay, which is $500 per month. Can you afford that on your cash basis? Do it!
  4. Interest is an expense that has to be paid monthly. It's going to be over and above the amount you just decided you wanted to pay down your debt by each month. Can you afford that, too? If not, then you have to reduce your monthly pay down.
  5. Pick an account to pay off first. To absolutely minimize the total payout over the time your paying off your debt, it ought to be the one with the highest interest rate, but for getting started, it might be better to pick the one with the lowest balance, so you can get one paid off period.
  6. Pay the minimum monthly payment on all the revolving accounts except the one you've decided to pay off first.
  7. How much do you pay on the one you're paying off? Take the amount you want to reduce your revolving debt by each month ($500 in the above example). Subtract the minimum payments you made on the other cards in the last month, but add back the amount of interest you were charged over the last month in all the accounts. That's how much you pay on the one you're paying off first.

For example, if you're paying $500 per month, as in the example above, and you have three accounts, one with a minimum payment of $20 with $5 interest, one with a minimum payment of $50 with $15 interest, and the one you're trying to pay off which had an interest charge of $35 that month, you would pay $20 and $50 on the first two bills, then $500 (the total principal pay down) - $20 - $50
(what you paid in principal on the other two accounts) + $5 + $15 + $35 (the interest on all three accounts) = $485 payment to the one you're paying down. You are paying down the owed principal by $500, and you are paying the total current interest of $55 with your total payments of $20 + $50 + $485 = $555.

That's my system. The wrinkle is that you always view the interest component of the payment as a current expense, and so you can manage how you're paying down the prinicipal. If you simply allocate amount $X to total monthly bill payment, you're only paying down by $X less the interest expense.

As you pay down your debt and as your financial situation improves, you can increase the amount you pay down the principal by each month, increasing the rate at which you get out of credit card debt. (We'll have our own paid off by the end of this calendar year.) Also, when your total balance gets sufficiently low, you may be able to transfer balances to a 0% interest rate account that you'll pay off completely before the interest rate becomes non-negligible. I'm investigating that for us currently. In general, though, you want to pay off the lowest interest rate account last.

Oh yeah: There's nothing wrong with using plastic as a charge card, whether it's a revolving account or a charge account. To do that, though, you have to have one account that gets paid off each and every month; otherwise, you are not on a cash basis. We use an one account that gets us points in a hotel program for almost everything, then we use the points for free lodging.

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