What’s the best way to pay down holiday debt?
U.S. consumers spent more per day in December than in any month in about nine years, a new Gallup tracking survey found. So the odds are good America’s $747 billion credit card balance grew larger over the holidays.
But it’s a new year, and you’re looking to pay down your debt. This is always a smart resolution, especially so now that credit card interest rates are increasing.
Where to start? You need a strategy.
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Researchers from several universities may have found the best one: Pay off your smallest debt first.
Otherwise known as the debt snowball method, this strategy is designed for people who carry balances across multiple credit cards.
Using this method, you’d make just the minimum payment on all credit card balances. Any extra money you can find in your budget would then go toward the smallest debt. Continue until that card is paid off and then move on to the new smallest debt and repeat the process.
What the research found
The researchers studied three years of anonymous credit card data from about 6,000 clients of HelloWallet, a financial guidance firm that works with other companies and their employees. They found that people who focused on paying off one account rather than dispersing payments equally across all accounts ultimately paid down more of their debt.
One big reason: People tend to enjoy small victories.
“We tested a variety of hypotheses and ultimately determined that it is not the size of the repayment or how little is left on the card after a payment that has the biggest impact on people’s perception of progress; rather it’s what portion of the balance they succeed in paying off,” Remi Trudel, an assistant professor of marketing at Questrom School of Business at Boston University, wrote in the Harvard Business Review. “Thus focusing on paying down the account with the smallest balance tends to have the most powerful effect on people’s sense of progress — and therefore their motivation to continue paying down their debts.”
Previous research, including a 2012 Northwestern University study, found similar results.
“To the extent that a consumer’s debt accounts have similar interest rates, he or she should concentrate repayments first on the cards or accounts with the smallest debts, paying off those first,” Trudel wrote. “And unless it’s possible to consolidate those debts at a substantially lower rate, our findings would argue against pooling debts into a single larger one as this can actually be demotivating and could slow progress in repayment.”
That means, unless you can find a no-interest balance transfer card, this strategy might be your best bet.
Downside to this method
The snowball method is not without its faults, though.
Although paying your smallest debt first may prove motivational, it may not be the cheapest way to rid yourself of credit card debt, particularly if you have other debt that carries a higher interest rate.
Paying off the most expensive balance first — known as the debt avalanche method — could save you thousands of dollars in interest payments.
Of course, this method is only cheapest if you stick to it.
The best advice: Pick a way to pay down your debts that you suspect will work best for you.
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The Federal Reserve’s move last month to increase a benchmark interest rate is beginning to have cascading effects on credit card annual percentage rates. As I wrote earlier this week, all 14 of the credit cards I began tracking in November have raised their rates by 0.25 percentage points, mirroring the Fed hike.
Now, we’re beginning to see average interest rates creep up.
In Bankrate’s latest weekly credit card survey, the average APR ticked up to 16.30 percent, up 0.03 percentage points.
The average APR is now barely off the 2016 high of 16.31 percent, which is the highest national average in at least the last five years, according to Bankrate data.
Bad credit, bad
An analysis of Consumer Financial Protection Bureau data by the student loan marketplace LendEDU found that nearly a quarter of all complaints filed with the government agency in 2016 were about credit reports and credit bureaus.
Consumers filed more complaints about this topic (43,206) than any other financial product or service, including mortgages, credit cards and debt collection.
Nearly three-quarters of the complaints focused on the same issue: Consumers found incorrect information on their credit report.
Complaints about credit reports are nothing new. Last spring, comedian John Oliver put together a hilarious 18-minute takedown of the credit bureaus on his HBO show “Last Week Tonight” over the bureaus’ decades-long problems with fixing credit report errors.
But horror stories abound about what happens to a consumer’s credit when they can’t get the bureaus to correct errors.
The lesson: Contact the CFPB if you’re having trouble getting your issue resolved.
Trying to get your credit score higher is like playing a really hard game that's almost impossible. ???? #Annoying
— Jenelle Evans (@PBandJenelley_1) January 2, 2017
Jenelle Evans, one of four women featured on the MTV reality show “Teen Mom 2,” wrote the above tweet. Her assertion here is entirely incorrect.
It is not “almost impossible” to increase your credit score. If you do the right things, it’s actually pretty easy, but it does take discipline and patience.
- Always pay your bills on time.
- Don’t use too much of your available credit.
I’m grateful the Twitter community quickly tried to set Evans on the right path.
— Mrs. Coach Hackbarth (@TrcyHckbrth) January 2, 2017