The Best Strategy to Pay Down Credit Card Debt

Paying down debt is always a good way to improve your finances, but the way you go about it can make a difference in your bottom line.
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The preferred way to pay down credit card debt is the one where you pay down the highest cost debt, Jeffrey Levine, chief planning officer at Buckingham Wealth Partners, said in a recent interview.

According to Levine, there are two main ways of paying down your credit card debt.

The Snowball Method

One is the snowball method, which is Dave Ramsey’s preferred method. With this method, you would:

  • Step 1: List your debts from smallest to largest regardless of interest rate.
  • Step 2: Make minimum payments on all your debts except the smallest.
  • Step 3: Pay as much as possible on your smallest debt.
  • Step 4: Repeat until each debt is paid in full.

That method produces “little wins,” said Levine. But it doesn’t, however, result in your paying the lowest cost for that debt.

“I categorically reject this as a viable strategy for most,” he said. “If it's the only way that you're going to commit to paying off debt… perhaps there's an exception to the rule there. But it is actually a wealth-destructive approach to paying off debt.”

The Avalanche Method

Levine’s preferred method, by contrast, is a variation on what some refer to as the avalanche. The avalanche method would have you pay down the debt with the highest interest rate first. Levine’s preferred method is to focus on the highest cost debt. Generally, that's going to be the one with the highest interest rate, but there are some exceptions.

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For instance, the interest rate on your student loans may be modestly higher than another debt that you have. “But if you take into consideration your student loan interest deduction that perhaps you get, maybe the net is lower,” he said.

If you can't figure out which is your highest cost debt, then paying down the debt with the highest interest rate amount is a good place to start, he said, noting that this strategy is for “wealth destructive debt,” credit card or other types of debt that have shorter time horizons versus, say, a mortgage.

“In order to tackle those (debts) in the most effective way possible, you want to pay off the thing that costs you the most,” said Levine. “Focus on your total amount of debt. Let that be the rush you get. And if you want to see your total amount of outstanding debt drop the fastest, start with the debt that costs you the most.”

Here’s a basic example of the difference between the two strategies using Vertex42’s free online debt reduction calculator.

Let’s say you have a balance on two credit cards. Credit card No. 1 has a balance due of $1,000, an interest rate of 22% and you’re making the minimum payment of $20 a month. Credit card No. 2 has a balance due of $500, an interest rate of 19% and you’re making the minimum payment of $10 a month.

If all you did was make the minimum payments, it would take 122 months to pay down credit card No. 1 and you’d pay total interest of $1,648.03. It would take 100 months to pay down credit card No. 2 and you’d pay total interest of $498.52. The total interest cost of both would be $2,146.55.

Now let’s say you have an extra $70 a month to pay on your credit cards. With the snowball method, your total interest cost would be $263.90 and with the avalanche method, your total interest cost would be $247.75, a small difference of $16.15. But the difference goes into your pocket, not the credit card company’s pocket.

Of note, Levine’s preferred method recently sparked a fair amount of discussion on his Twitter  (TWTR) - Get Report account (@cpaplanner), with many commenting that the snowball method, among other things, provides psychological benefits.

“We can stare at the numbers and do math all day to ‘pay down the fastest,’” AJ Erzen (@AJ_Erzen), a wealth adviser with CarsonAllaria Wealth Management, wrote on Twitter. “Paying off a smaller amount and getting a ‘win’ does in fact work better for most. I see it every day. They sense accomplishment, even though it might not be the most efficient.”

And Ted Perry (@Tedwardperry) wrote the following on Twitter: “Mathematically, I'm with you (Levine) but, for some, the victories from paying off the smallest balances can provide the momentum needed to sustain (the) strategy. Sticking to a strategy long-term will likely result in (the) lowest interest paid. Sustainable improvement >mathematical perfection.”

For his part, Levine, on Twitter, agreed that if you “need” those victories, the snowball method can be useful. “But I also think if people were coached better and advisers were able to reframe it better from “number of bills” to “total debt reduction” FAR fewer people would “need” to use that method.”

Said Levine in the interview: “If you hate debt and you hate paying debt, then do the thing that's going to stop you from paying debt faster and that's paying down the debt that is a higher cost to you… It just doesn't make sense to look to focus on the dollar amount of the outstanding debt. Start with the highest rate or cost first and work your way down from there… It drives me crazy to see people who already may be struggling with their finances, struggle more because of what is really bad advice. And that snowball method is, well, there's not a snowball's chance that it works.”