Best way to allocate lump sum across multiple card debts

To Her Credit columnist Sally Herigstad
Sally Herigstad is a certified public accountant and the author of "Help! I Can't Pay My Bills: Surviving a Financial Crisis" (St. Martin's Press, 2006). She writes "To Her Credit," a weekly reader Q&A column about issues involving women, credit and debt, for, and also wrote for MSN Money, and, and has guested on Martha Stewart Radio and other programs.

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Question Dear Sally,
If I have a sum of $4,000, is it better for me to pay off one card with it or make $500 payments each to multiple cards? All my cards are close to being maxed out.  – April


Dear April,
The best way to use $4,000 to pay down credit card debt depends on what is most important to you, and what motivates you to pay down your debt and to keep paying it down until you are debt free.

Financial experts don’t all agree on how you should go about paying down credit card debt. Personal finance expert Dave Ramsey famously teaches the snowball method, which means you pay off the account with the lowest balance first, and then the next, and so forth – regardless of the interest rate on each account. Ramsey’s reasoning is that you receive a psychological boost when you pay off an account. It’s a simple plan, and it also offers the advantage that you soon have fewer payment due dates to worry about.

Other experts say you should pay down the cards with the highest interest rate first. That’s hard to argue with, especially if one interest rate is comparatively high. Mathematically, it’s the correct choice. You will pay down debt faster using the highest-rate-first method.

Another factor to consider, especially if your main concern is your credit score, is lowering your total debt in proportion to your available credit. This is called “credit utilization,” and the lower your credit utilization, the better. (Up to a very low point. You do want to show that you actually use your cards.)

In my opinion, your best bet is to consider all three factors to make the very best use of your $4,000 to pay down debt, save interest expense and improve your credit score. Here’s what I’d do:

If you have any cards with outrageous interest rates, pay them first, and fast! For example, say you owe $4,000 to one card with a 30 percent interest rate, and $10,000 to various cards with interest rates between 10 and 20 percent. Put the entire $4,000 on the card with the high rate. High interest rates can be financially devastating as those interest charges just feed your balance. Once that card is gone, you’ll be able to work on the others.

After you’ve paid off any card with a much higher interest rate than the others, look for any low balance cards you can knock off. For example, if you have a bunch of cards with a low balance on each, consider paying them off next. Not only will you get that psychological boost that Dave Ramsey talks about, but you won’t owe a minimum payment on those cards from now on. That improves your cash flow and simplifies your life.

If you’ve paid off the very high interest rate cards and the very low balance cards, and you still have money you can use to pay down any remaining card debt, I would spread that money between the remaining cards. The reason is that credit scoring models don’t just look at credit utilization as how much of your total available credit you use across all your cards. They also look at individual credit cards that are maxed out. Your goal is to pay down both the individual cards’ utilization percentage, and the total percentage of all cards, because both are counted in your credit score. Your score will improve incrementally as you knock down the balances.

Don’t be in a hurry to close your cards as you pay them off. If you do, your score may get worse instead of better, at least temporarily. That’s because as you lose those credit lines, you’ll have less total credit available, so the amount you still owe in proportion to it won’t improve. Only close accounts when you’ve considered your overall credit utilization ratio, as well as which accounts you’ve had the longest (you should generally keep your oldest cards open), and which cards you really want to keep.

After you apply the $4,000 to your debts, the trick is to stop adding to your balances and to keep paying at least as much on your cards every month as you did before you got the $4,000. If you can keep that up, you may be surprised how quickly you can pay off your total debt, and start making progress on all your financial goals.

See related: Payoff order for multiple cards: Which one first?, Debt shifting helps your score, but paying it off is better

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Updated: 01-22-2018