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Prioritize payments wisely to knock down debts

By

Opening Credits
Columnist Erica Sandberg
Erica Sandberg is a prominent personal finance authority and author of "Expecting Money: The Essential Financial Plan for New and Growing Families." She writes "Opening Credits," a weekly reader Q&A column about issues for people who are new to credit, for CreditCards.com.

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Question for the CreditCards.com expert

Dear Opening Credits,
Please help me. I have a car loan of $19,500 with an interest rate of 8.6 percent. I have two credit cards with Chase, and both of them have a balance of $6,000 each. The interest rate for one is 12 percent, and the other is 24 percent. I also have a loan of $4,000 with an interest rate of 17 percent. I'm making my monthly payments on time, but I don't know which loan I should pay first. Please advise. I would like to be debt free soon. I'm 26 years, and I'm a single mom. -- Marilu 

Answer for the CreditCards.com expert

Dear Marilu,
Before delving into how you can quickly and economically pay off your balances, I'm going to implore you to do one thing if you haven't already, stop borrowing money immediately.

Living in debt robs your family of cash necessary for financial security. By owing $35,000, you are paying hundreds of dollars each month in finance charges -- money much better spent running your household and preparing for important future goals. Not only that, adding to the balances as you're working toward your debt-free objective is counterproductive. The primary reason credit counseling agencies' debt management plans are effective is that their clients agree to close existing accounts and not apply for new ones while participating in the program. Such strict guidelines are an integral part of learning to live within one's means.

So, Marilu, are you ready to live a cash-only lifestyle for a while? If the prospect has you biting your nails, gain confidence by developing a budget that allows you to methodically direct funds to key costs. This exercise will also help you determine the amount of money you have to apply to your liabilities:

  1. Write down the total of your monthly net income.
  2. List and total all monthly expenses, including cash set aside for savings and periodic costs such as home maintenance and medical expenses.
  3. Subtract your expenses from your income.
  4. Reserve the remaining sum to divvy up among your creditors.

Now, about your debt: If you're making just the minimum requested payments, it's time to "power pay." Establish the maximum sum you can regularly promise to your creditors by revisiting and refining your budget. Identify ways to earn more and/or pare down. As you're doing so, avoid being ridiculously frugal -- noodles every night is neither reasonable nor healthy -- and overly liberal -- manicures are not, and never will be, a vital expense.

Once you know your guaranteed base figure, look at the numbers for all accounts in the order listed in your letter, with their estimated minimum payments:

Debt type

Debt amount

Interest rate

Payment

Months to repay

Total cost

Car loan*

$19,500

8.6%

$432

55

$4,164

Lowest-interest credit card

$6,000

12%

$150

52

$1,724

Highest-interest credit card

$6,000

24%

$150

82

$6,257

Unsecured loan

$4,000

17%

$198

24

$750

Total finance charges

$12,895

* Approximate figures, assuming 55 months left on a 60-month, $21,000 loan

Next, prioritize the accounts by interest rate, adding extra funds -- I've proposed an additional $200 -- to the one with the highest rate and leaving the others the same:

Debt type

Debt amount

Interest rate

Payment

Months to repay

Total cost

Highest-interest credit card

$6,000

24%

$350

22

$1,476

Unsecured loan

$4,000

17%

$198

24

$750

Lowest-interest credit card

$6,000

12%

$150

52

$1,724

Car loan*

$19,500

8.6%

$432

55

$4,164

Total finance charges

$8,114

* Approximate figures, assuming 55 months left on a 60-month, $21,000 loan

As you can see, the increased payment to the credit card with the highest rate made every month until payoff would shave $4,781 in total finance charges. Even better, when that debt is gone in 22 months rather than 82, you can use that $350 to add to the account with the next highest interest rate, the unsecured loan. When that's done, send it to the remaining credit card. (Pssst, this constant reapplication system is the other reason credit counseling plans work so well.)

That leaves the car loan. Once your unsecured debts are paid, you should have $700 more in your pocket to work with on a monthly basis. Though the rate of 8.6 percent is not terrible, after you've deleted your other balances, you may be in the perfect position to refinance. "Compare multiple lenders online," says Dale Peterson, president of myAutoloan.com. "With rates being at a low these days, it's possible to get a 6 percent loan." Such a reduction would decrease the payout time and finance charges further, efficiently eradicating the final debt. 

Finally, Marilu, part of our job as parents -- single or otherwise -- is to teach financial acumen and responsibility to our children. Therefore, consider this the ideal opportunity to educate. In age-appropriate language, explain what happened and how you're fixing the problem. Then lead by example. Your commitment and ultimate success will be an invaluable lesson for them, and a source of immeasurable pride for you.

See related: Credit card calculator: What will it take to pay off my current balance?, 8 things you must know about credit card debt

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Does a personal finance problem have you worried? Monday through Saturday, CreditCards.com's Q&A experts answer questions from readers. Ask a question, or click on any expert to see their previous answers.

Published: June 3, 2009


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Updated: 12-03-2016


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