Identifying the Best Way to Reduce Credit Card Debt
Learn how to compare debt reduction strategies to find the best solution for you.
Finding a solution to reduce credit card debt can be tricky, because there are different ways to achieve your goal. Not every solution works in every situation; the path that your neighbor took to get out of debt may not work for you. So, how do you compare debt relief options to find the best way to reduce credit card debt in your unique financial situation?
3 factors matter when you want credit card debt:
To find the right solution for you, there are three factors you need to consider:
- Time – i.e. how long will it take to reduce your debt?
- Monthly cost – i.e. can you afford the payments?
- Total cost – i.e. how much will it cost once you total up interest charges?
Time often relates directly to both costs. An elimination plan that takes longer will cost more in total, but often has lower monthly costs. If you want to reduce debt quickly, the monthly costs will typically be higher, but the total cost is often less. That’s because a shorter time frame means fewer months to apply interest charges.
This means that to find the best way to reduce credit card debt you need to look for a solution that offers the highest possible payments that fit within your budget at the lowest APR. This solution will allow you to get out of debt as quickly as possible, while minimizing total interest charges.
Comparing ways to reduce debt
To show you how to compare options, let’s look at a straightforward example of credit card debt. Let’s say you have $25,000 of debt to eliminate at an average credit card APR of 18%. Your cards have a standard minimum payment schedule of 2% of your balance each month. We do the math on a few different options below.
Reducing this much debt with minimum payments
Credit cards are revolving debts, so the minimum payment requirement changes based on how much you owe. The starting payment in this situation would be $500. If you only make the minimum payments and don’t put any strategy to eliminate the debt faster, it will take 793 payments to pay off this debt. That’s 66 years spent paying off your credit cards.
During that time, total interest charges would be $73,396.66, making your total cost $93,396.66. That’s right – if you only ever make minimum payments, you almost quadruple your costs.
Paying more than the minimum
One strategy to reduce debt faster is to put extra money towards the payment each month. For instance, you commit to paying the minimum plus $100 extra each month. If you did this, you save 631 payments and $49,932.08 in interest charges over the minimum payment schedule.
In total, it will take 162 months (13.5 years) to eliminate your debt this way. Interest charges would equal $26,464.58 for a total cost of $51,464.58. So, even though this is better, it still takes over a decade and doubles the cost of your debt.
Setting up a fixed payment schedule
Another way to reduce debt quickly is to set a fixed payment schedule. This is basically where you set a payment that’s equal to or higher than the original minimum payment. Then, you make that fixed payment regardless of the minimum requirement.
So, let’s say you can afford to make $750 fixed payments each month. This would only take 47 months to eliminate your debt, meaning less than four years. Total interest charges would be $9,918.02 for a total cost of $34,918.02.
Most experts agree that a good debt elimination plan should take no more than five years. So, if you can make $750 fixed payments work, this is a viable solution to reduce your debt. Still, you should take the extra step of comparing other available options before you make your decision.
Exploring alternative ways of reducing debt through consolidation
Balance transfer credit card
This is where you transfer your existing balances to a new credit card that offers 0% APR on balance transfers. That introductory rate only applies for a short time after you open the account. This means you need to be able to afford monthly payments high enough to pay off your balance before the standard APR kicks in.
If you have excellent credit, let’s say you get a card that offers 0% APR for 24 months (2 years). Balance transfer credit cards often have a 3% transfer fee, so that would add $750 to your balance. In order to pay off the balance in full within 24 months, you would need to make monthly payments of at least $1,073 per month.
However, if you can afford that, you pay off the debt interest-free, meaning your total cost is only $25,750. The monthly payments are high, but this would be an extremely cost-effective way to pay off your debt.
Personal consolidation loan
Another solution is to use a low-interest personal consolidation loan to pay off your balances. In this case, you’d take out a $25,000 loan because that’s big enough to pay off your balances. With excellent credit, let’s say you qualify for an interest rate of 5% APR.
- If you choose a 36-month term the loan payments would be $749.27; you would pay $1,973.81 in total interest charges for a total cost of $26,973.81
- On a 48-month term, the payments would be $575.73 with total interest charges of $2,635.15; that’s a total cost of $27,635.15
If you compare the 36-month loan to the fixed payment reduction strategy, the minimum payments are the same. However, you save 11 months and $7,944.21 in total interest charges, making this a better option.
Debt management program
This is a type of assisted debt consolidation, where you enroll in a voluntary repayment plan through a credit counselling agency. The advantage here is that your credit score is not a factor for qualification. This means you can use a debt management program to find debt relief even if you have bad credit. A 600 score would make other consolidation options difficult to use, even if you can qualify.
Results vary, but most clients see their total monthly payments reduced by 30 to 50%. The credit counselling team usually negotiates interest rates between 0-11%. Most people successfully complete the program within 36 to 60 payments.
For more information and to enroll in our debt management program, call 1-844-402-3073 and one of our trained credit counsellors will be happy to assist you.