There are a couple of effective strategies to pay down debt quickly. All involve paying more than the minimum payment.
One is to list all your debts and pay off the smallest amount first, then the next largest amount, and then the next largest amount. It has the psychological benefit of letting you see the number of debts disappear quickly. The is called the debt snowball.
The debt rolldown is some what different. Again, you list all your debts. But here you pay off the highest interest rate debt first, followed by the second highest, etc. All other things being equal, the rolldown should let you pay off your debts quicker and save you more interest expense.
But over the years, I had accepted several lifetime balance transfer offers. On just one card, for instance, two different rates applied — 27.64% and 3.99%. On another card, three different rates applied: 7.90% ($2671), 5.49% ($1659) and 5.99% (5,000).
That meant that highest rate card might differ from month to month. When I began, the highest rate card had a 27.64% interest rate. But after nine months of payments, that 27.64% balance had been paid off. What was left was a promotional balance transfer with a rate of 3.99%.
It would make no sense to make big payments on a balance with a 3.99% interest rate while making a minimal payment on a card with a 16.24% interest rate.
My goal was always to make an extra payment — around $650 a month extra — on the highest interest rate balance, regardless of what card that balance was on. As one high rate balance was paid off, I would then shift to the next highest balance.
To manage this, I created a spreadsheet with the following columns:
- Card name
- Highest current rate on that card
- Credit Limit for that card
- Current balance on that card
- Interest paid on an annual basis
Interest paid on an annual basis is calculated simply by multiplying the highest current rate on that card by the current balance.
Each month I would review all credit card statements as they came in, entering the new current balance and verifying the interest rate that applied to that balance.
I would then use the spreadsheet’s sort function to put the highest interest rate at the top of my page. It wasn’t strictly necessary to do so, but since I had eight cards with balances, it made it easy to see what the highest rate card was.
Each spreadsheet column was totaled.
I then created two additional calculations:
- Current balance to maximum credit. This is a simple calculation: divide the total current balance by the total of the maximum credit column. It will give you a percentage figure. When I began, the ratio was about 85%. As I write this, it’s now down to 69.95%.
- Effective annual interest rate. This, too, is a simple calculation: divide the total annual interest paid by the total current balance for all cards. When I began, the total interest I was paying was about 18% of my balance. A year later, the effective annual interest rate is 9.34%.
I decided my focus would be on that effective annual interest rate. My goal was to drive it as low as possible.
The first card I tackled was a card with a 27+% rate. But when I closely examined the statement, I noticed that it had a substantial balance transfer with a 3.99% rate for life.
So I focused on paying that card down. On all other cards I made the minimum payment. After several months, the 27+% portion of the card was paid off. Now, I was being charged 3.99% on about $13,000.
So that card went to the bottom of my spreadsheet, something that’s easy to do by using the spreadsheet’s sort feature. I simply highlight the interest rate column and sort all cards so that the highest rate card is at the top of the page and the lowest rate card is at the bottom.
In essence, what I set out to do was apply the “credit card rolldown” principle to a situation where the interest rates on various cards changes from month-to-month.
I then turned to the next credit card, which has a 16.24% rate, a rate that doesn’t change. Every month, I pay $765 on this card. Sometimes, if the checking account is flush, I make an extra payment. This card will be paid off in about five months.
I expect to get a balance transfer offer the very next month for this card. If the rate is acceptably low — perhaps 0% or 1.99% — I’ll use it to pay off the 15.24% American Express card. We’ll talk about balance transfer deals in the next chapter.
That will eliminate all my super-high-rate cards. The next card will be one with a 10.25% annual interest rate and a $65,000 balance. I’m currently paying $888 a month, the minimum payment, on this card. I’ll continue paying $888 a month — plus what I had been paying on the two highest rate cards, less whatever I’m paying on the balance transfer. For example:
- On the highest rate card (Card A) I was paying $765 a month.
- On the card I paid off with a balance transfer (Card B), I had been paying $105 a month.
- The two together total $870 a month.
- But as a result of the balance transfer of $4,500 to pay off the 15.24% card, I’ll repay that card $450 a month. That will leave $430 to apply to the next highest rate card (Card C), on which the interest rate is 10.25%.
- So, the amount I will apply to Card C will be $1318 — the total of $888 that I’ve been paying plus $430 from the two highest rate cards.
When Card C is paid off, I’ll turn to Card D, which has a 9.24% interest rate, applying exactly the same approach. Except Card D will have an even higher payment each month, because in addition to Card D’s minimum payment, I’ll also pay what I had been paying on all higher rate cards.
My spreadsheet was necessary in order to identify which card had the highest rate. But if your cards have the same rate — no promotional rates, balance transfer rates, etc. — there’s a dandy calculator at Dinkytown.com that will show how quickly your debt will be paid off.
In addition to the Dinkytown.com calculator, which is good to use once a year, I’ll continue to use my spreadsheet because that will show me both the effective interest rate and my debt ratio.
Dinkytown tells me that if I simply continue to make minimum payments, it’ll take 17 years and $60,443 in interest before all the debt has been paid off.
But using the debt rolldown approach, it will take less than five years to become debt free — and total interest paid will be just $26,306.