In a previous article, we discussed the cost of minimum payments and how making minimum payments on credit cards greatly extends the time it takes to pay off debt and leads to more interest costs compared to a strategy of holding your payments constant. But what should you do if you have more than one debt? What’s your best strategy then?
Let’s take a look at an example. Suppose you have 3 credit cards, all with $5000 balance and interest rates of 18%, 12%, and 9%. Furthermore, let’s assume that minimum payments for each account are 4% of the balance so they each start at $200 per month. With this example, there are 3 strategies:
- Pay minimums on each account until they are all paid off
- Pay $200 on each account until they are each paid off
- Pay $600 total, but allocate as much as possible to the highest-interest account until that account is paid off and then apply as much as possible to the next-highest account, etc.
So what does this look like? When would you be out of debt and how much would you pay in interest? Here’s a summary:
| Strategy |
Interest |
Years to Debt Free |
| Minimums Only |
$5,500 |
10.2
|
| $200 per month to each account |
$2,654 |
2.8
|
| $600 each month with allocation to highest-interest account |
$2,450 |
2.4
|
Clearly keeping your payments constant is still a good strategy, but you cut your interest costs by about 10% and get out of debt 5 months earlier by paying only the minimums on everything but your highest interest accounts and allocating the difference to the highest-interest account so you pay it off as quickly as possible. This approach is often called “debt stacking”.
Debt stacking is the most efficient way to get out of debt and its power grows with more accounts at different rates. If you were to add a $280K mortgage and a $15K auto loan to this scenario, how would that look?
| Strategy |
Interest |
Years to Debt Free |
| Minimums Only |
$365,877 |
29.9 |
| Debt Stacking |
$183,651 |
15.3 |
So with Debt Stacking, the borrower gets out of debt in half the time and cuts total interest costs by $180K. Wow! All that from just keeping payments constant over time at the initial minimum payment amounts.
So why doesn’t everyone do this? Often it’s just too complicated for most people to manage on their own. It requires creating a separate payment schedule each month to calculate the optimal payment on each account. For most people, it’s just easier to pay the minimum payment on their statements and credit card companies use this to their advantage. With this example, it’s relatively easy, but the average person in debt has 12 accounts and some have up to 30. With this many accounts, the calculations required to follow the Debt Stacking strategy is too much. So for many people, the cost of carrying many debt accounts is the paralyzing complexity that keeps them paying the amount on their statements instead of a more effective strategy. In this case, that cost is pretty steep–$180K.
DebtGoal.com helps users get organized and create and track to a debt reduction plan. Our application manages the complicated math required to create, follow, and track against an optimal debt payment strategy.
Scott Crawford is CEO of DebtGoal.com, a do-it-yourself system for getting out of debt and lowering your interest costs. DebtGoal.com incorporates all of the techniques discussed in this post and can help users understand and get visibility to and manage their debt finances.
Tags: debt reduction, Debt Stacking, DebtGoal, snowball
