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by sitecore\kmcgrigg on May 05, 2011

In honor of Financial Literacy Month, Jean Chatzky, author and financial editor for the Today Show, is personally responding to five consumer questions. Today, Jean answers Terrence's question about the best way to repay debt.

Best Way to Pay Off Debt

Question: Is it financially savvy to pay off credit cards with the highest rates first or lowest balances first? I've heard pro's for each. Lowest balances first being that you free up minimum payments which can be added to payments on the next ascending balance card. Thank you in advance. -Terrence

Answer: You want to pay them off highest interest rates first. And in this example you’ll see why:

John has 5 credit cards. He owes:

$5,000 at 29.9 percent with no annual fee
$1,500 at 24.9 percent with a $49 annual fee
$700 at 27.9 percent with no annual fee
$600 at 7.9 percent with a $49 annual fee and
$400 at 11.9 percent with no annual fee
Total debt: $8,200

Option 1: Pay as much as you can afford on the card with the highest interest rate, while making just the minimums on the others. Let’s say John can afford to pay $350 a month, total. Assuming his minimum monthly payments are calculated as 2.5% of the card’s balance, at the onset, $206 of that will go just toward meeting those. He can then start by putting the remaining $144 toward the first card, with the 29.9 percent interest rate. His end result:

Debt repayment scenario #1

Total interest paid: $3,266.46

Option 2: Pay off the cards with the lowest balances first while making the minimums on the others. Assuming John still has $350 to throw at his credit card debt each month, and the minimums on the cards are the same, he’s still left with $144 extra to go toward the card with the lowest balance, Card #5 in the above calculation. Here’s how it shakes out:

Debt repayment scenario #2

 

 

 

Total interest paid: $3,933.12 – a difference of about $666, or a big boost to your savings account.

 

You might also enjoy reading:

Jean Chatzky's response to Patricia's question about opening an IRA
Jean Chatzky's response to Danielle about new financial advice 
Jean Chatzky's response to Nicole's question about draining savings to repay debt
Jean Chatzky's response to Laurie's question about financial iPad apps

Comment(s)

Anonymous says:
May 10, 2011

This is a verndale test.



Nate says:
May 05, 2011

I respectfully disagree. While you are absolutely right numerically, personal finance is less about the numbers then it is about the behaviors. Let's face it, if it was about the numbers most of us would never go into debt. Using your chart it will be mrs than 2 years before the first debt is paid off. A lot of people will have given up before reaching that point. By paying off the smallest debt first you get your first victory only 3 Months in and have 3 debts paid off before the end of year one! For me, the emotional boost is worth the extra $19.03 per month. That all said, I celebrate being debt free no matter how the person got there!



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