The best way to repay credit cards
You’re doing it wrong.
Juggling balances across multiple credit cards means it’s highly likely you’re repaying your plastic in a way that is costing you.
If you can’t pay the balance for all cards in full each month, optimizing your payments with some simple math is the best plan — you’ll pay the least interest and save the most money.
Start by paying the minimum monthly payment for each, and then work to pay off the card with the highest interest rate first. Sounds like a straightforward, common sense approach, right? Not for everyone.
In a recent study from the U.S. National Bureau of Economics Research, analysts found that consumers fail to use good mathematical sense with their credit card payments because they tend to ignore interest rates.
The study found that an average, two-card household in the U.K. paid an extra $90 (about $115 Canadian) a year in interest because of how they divided their payments. The most indebted households, with more than five credit cards, paid $1,000 (about $1,300 Canadian) a year in unnecessary interest. This exorbitant amount could have been avoided — by consumers who least needed the additional costs — just by focusing on repaying the highest interest cards first.
While some people aim to pay off the smaller debt first for a psychological win, researchers found the majority overpaid in interest by “balance matching” debt repayment.
Balance matching? Throwing math and logic aside, this is where individuals make payments in proportion to the overall amounts owed. For example, let’s say you owe $5,000 on one card and $2,500 on another and you have $1,200 to put toward your plastic this month. Researchers found the average person would pay $800 on the larger balance and $400 on the smaller one without considering interest rates or the cost of compounding debt.
The study found our human brains are susceptible to making logic errors because, in part, credit card balances are the first numbers we see on statements. This total amount owed often weighs heavily on our minds and affects our decision-making process when choosing payment amounts.
Another big mistake people make is focusing on minimum payments. A 2017 study by TransUnion Canada, a creditand risk-reporting website, found that while 47 per cent of Canadians pay off their credit cards in full each month, 39 per cent are uncertain about the benefits of paying off more than the minimum balance. And 10 per cent pay exactly the minimum required each month.
Look, I’m a fan of keeping onside with creditors by keeping up with minimums. But it’s costing you a lot to let the card statement convince you that the minimum is the maximum required.
Let’s say you have a $2,500 balance at 19.99 per cent and pay the initial minimum monthly amount of $75. At this rate, it will take you 16 years and eight months to pay that plastic off. Plus you’ll pay the bank $2,862 in interest — double your initial balance — for a total of $5,362.
Want to really kill that balance and save on interest? Let’s ignore the banker’s suggested minimum and pay a fixed amount of $100 every month.
By paying just $25 more over the suggested minimum, you’ll knock off your credit card balance 13 years and 11 months sooner, plus you’ll save $2,101 in interest. The total interest paid is $760, plus you’ll get out of debt a decade sooner.
No wonder banks love it when you pay just the minimum.
The bottom line is, to get out of debt the fastest with the least amount of interest, you must strategically pay off your credit cards by repaying the cards with the highest interest rates first. And you must pay more than minimum amount. The math is really that simple.
Check out the Financial Consumer Agency of Canada’s Credit Card Payment Calculator for inspiration to go beyond balance matching and minimum payments.