Credit Card Question
Just the other day someone searched for the following phrase in Google and found my site:
“is it best to pay off my credit card balance in full or make minimum payments?”
Hopefully this searcher found some good information here. But I doubt he/she was able to find a quick answer to this question. In an effort to appease this reader I thought I’d answer this question best I can in a quick post. I’m going to take some liberties with this question and assume the person was asking whether they should pay off the full balance on their card or make minimum payments. Here are the factors to consider when answering this question as every situation is different.
The Interest Rate on the Card
The first thing you should do is find out what type of interest charges you will be incurring if you do not pay off the credit card balance by the end of the billing term. You can find this amount on your credit card bill. Keep in mind there are usually different interest rates associated with different types of balances. Be sure and pay attention to what type of balance you have. In other words, if you simply purchased something with this card (i.e. food, clothes) then look for the interest rate that applies to purchases. If it’s a transferred balance, then it’s going to have a different rate. The same goes for cash advances.
If the interest rate is above 10% then you should try and pay off the complete balance. You will be paying a great deal in interest charges to keep this balance. Another way to think about it: that new outfit or flat screen tv you bought will end up costing you well over the purchase price, likely double, if you pay off the card with minimum payments.
If you’re card’s interest rate is 0-4% due to some special promotion, then it’s okay to make the minimums as long as you are fully aware of the promotional rate terms (i.e. when it ends, promotional balance vs regular balance). The reason the minimum is acceptable in this situation is because the money you would use to pay off the full balance is better used elsewhere. For instance, it could be in an ING DIRECT savings account and be earning close to 2%, or you could invest it in a Roth IRA.
Lastly, if the interest rate is somewhere in between, 5-9% (a rarity), then you should let the following other factors influence your decision, as interest rate is somewhat of a non-factor at these levels.
Total Balance of the Card vs. Your Short-Term Savings
The second factor I would consider is the balance on the card compared to your short-term savings balance. Again, look at your statement and find your total balance of your credit card debt. Assuming this is your only debt, compare that number to your short-term savings balance. Your short-term savings will be any savings you have not earmarked for retirement or your kid’s education. These funds are normally tax sheltered and are therefore, off limits when it comes to using for debt payoff.
As a general rule, if you have a decent amount of savings, say $500-$1000, and your credit card balance is less than half that amount, $250-$500, then you should pay off the credit card in full. If your short-term savings is smaller than $500, then I would consider getting it to that level prior to making any extra debt payments. My advice would be to make the minimum payment on your debt until you build up a decent level of savings. Then, every dollar over that amount would be put towards paying off the debt.
As an extra step, if you find yourself unable to pay off the full amount of credit card debt due to a low savings balance, consider transferring your debt to one of the best 0% balance transfer credit cards available today.
Your Risk Tolerance
Lastly, let’s look at your level of risk tolerance. The numbers above do have some meaning for your decision, but they aren’t everything. And they can be trumped by how you feel about your debt. For example, let’s say you have a credit card balance of $500, but it’s at a special promotion interest rate of 0%. Also, you have $2000 in savings. It would then make sense, strictly from a numbers standpoint, to make the minimum payments on your credit card balance and continue funding your savings account. However, if that $500 balance is keeping you up at night or making you feel uneasy about your financial situation or if you don’t trust yourself to remember to make the minimums (you’re scared of missing a payment), then it would probably be best to just wipe it out and pay it all off.
A Few Examples
I’ve put together a few examples in graphical format to serve as an easy guide for making this decision.
Final Thoughts
Keep in mind these are just a few simple scenarios. Each situation is unique and should be analyzed separately. Please use the above information only as a guide or framework for deciding how best to pay off your debt. I know some could probably do a better job of breaking down all the numbers in more detail and include tax and time value of money implications, but this is just my take on how to handle credit card balance decisions. Best of luck getting out of debt.
Do you have some thoughts on this question? Please use the comment box below to share your thoughts.
Photo: by hoyasmeg
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Chase doesn't appear to be interested in helping their credit card customers pay off their credit cards. They offer only two choices under their auto pay system: pay the minimum or pay the full balance. All of my other credit cards let me set up an auto pay for: the minimum, a set amount or the minimum plus a set amount, or the full balance every month. The only way to make a payment of more than the minimum is to log in every month and manually send them money. It seems an obstructive stance.
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