Credit card debt is a drag.

By Tara Schatz

AAA World Article

Credit card debt is a drag. It is no fun paying for something this month that was purchased last month or even several years ago. The principal, interest, and fees going to creditors each month could instead pay for an Icelandic vacation, fulfill a savings goal or fund a retirement investment account (it’s never too late to save!). One of the fastest ways to increase disposable income is to decrease debt payments. But how do you do that? There are many strategies for paying down debt. General rules include paying more than the minimum payment each month on at least one account and not adding to the credit card balance. Here are some other approaches suggested by the pros:

Financial guru Dave Ramsey touts “the debt snowball” as the best way to pay off debt. The plan is to pay the minimum balance on all credit cards except the one with the smallest balance. All excess money is put on the account with the smallest balance. Once that account is paid off, move to the newest smallest balance account, paying the minimum plus whatever was previously going to the now paid off account.

The foundation of this suggestion makes psychological sense. Knocking off the smallest debt first may provide the encouragement and momentum needed to stick with a debt-reduction plan. The approach, however, ignores the effect having cards with high balances has on your credit score. The approach also does not take advantage of cost savings along the way that can be realized by moving debt to accounts with lower interest rates or by paying off the card with the highest interest rate first.

Determine which credit card has the highest annual percentage rate (APR) and get the balance on that account down as quickly as possible. Use the same general method described above: pay the minimum on all accounts except the one with the highest interest. This strategy will save money on interest, which can then increase the amount that can be paid against the principal.

This method focuses most on maintaining a healthy credit score by controlling the debt-to-credit ratio on each credit card account (total debt divided by total extended credit). Thirty percent and under is a good target for the debt-to-credit ratio. Go above that ratio, and creditors get nervous and your credit scores may dip. Figure out which one of your accounts has the highest debt-to-credit ratio and use the above pay down method to get the ratio below 30 percent as fast as possible.

Balance transfer offers may not be extended to consumers with high debt and a poor credit score, but as your debt situation improves, so will the offers available to you. Check offers available on current accounts before opening new accounts. A typical offer might be 0 percent interest for 18 months with a 5 percent fee. Before accepting a balance transfer offer, be sure you can pay off the transferred balance in full before the offer term expires.

As with balance transfers, personal loan offers from banks may not be available to all consumers. Once they become available, however, taking out a personal loan at a lower interest rate than your credit cards charge might be a good idea. The money borrowed can be used to pay off a higher interest rate credit card, saving you money on interest that can then be used to pay down principal. The loan can even be split up to pay off multiple creditors at once. Third-party companies, such as Consolidated Credit or National Debt Relief, offer debt-consolidation services, but the service may come with a set-up fee and monthly service fees.

This option is a last resort, especially if you will need a good credit score anytime soon for things like buying a house or a car. The reason is that many debt settlement programs call for technically stopping payments to your credit card companies. This will hurt your credit score in the short term, as payments will appear late. When the debt is finally paid off, credit reports will show debt as settled instead of paid, a less favorable status that will remain on your credit report for seven years. People have climbed out of debt using a third-party company’s assistance, but many others have been taken by a scam. Before signing any contracts, check for complaints against the debt settlement program with the State Attorney General or the Better Business Bureau.