Debt reduction plan interest rate question?
I am trying to set up a debt reduction plan where I pay off the account with the highest interest rate first, then move to the next highest, etc. My question is, which interest rate on my credit card statement do I use for this prioritization? There’s an Annual Percentage Rate and an Effective Percentage Rate and then I think there was still another. On one of my cards, these range from like 8% to 29% depending on which one you look at. It’s a shame I’m such an idiot when it comes to these things ! Thanks for any help…
Howdy, I answered this question for you at www.coddleshell.com – my own personal finance blog. I’ve pasted the answer below, I hope it helps!
Good question, you shouldn’t feel so bad about not knowing what is what when it comes to credit cards. They can be a dangerous tool as I’m sure you are now finding out. You’re right on with trying to reduce debt, starting with the highest intrest rate and working yourself down.
Both rates, the annual percentage rate (APR) and the effective interest rate (EIR) are both the same rates. Confused? So is the majority of everyone else.
An APR is a way to standardize and compare interest rates among lenders. It is an annualized rate that takes into account the total cost of borrowing. It is intended to standardize rates, as stated before.
The EIR is the rate you’re paying compounded X number of times per year, usually 12. Compounding means that every month, your balance is averaged (depending on the card and terms and conditions) and that amount is used to calculate the finance charges next month.
The other interest rates are probably rates like balance transfer or cash advances, etc. Don’t worry about those when comparing the cards.
To answer your question, in terms of comparing to another card, you should use the APR. The card with the highest APR should be paid off first, repeat this until you’ve got it all paid off.
6 Comments to “Debt reduction plan interest rate question?”
Go off the Effective APR.
This is what you are actually paying in interest, expressed as a percentage.
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well you could pay the high ones first but the low interest ones adds up too so i suggest paying all of them with the minimum atleast if you cant do as as much as possible highest to lowest. if your confuse about that percentage rate then i suggest you go to a friend that knows this stuff. if none of your friend knows how then try going to an accountant like HR block or something
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Doing this with the highest interest rate card is not the best way to do this…
what you should do is pay off the card with the smallest balance 1st while still paying the minimum on your other cards. When you have that one paid off you take all the money you were paying on that card and pay off the card with the next lowest balance. When that one is paid off you pay the next one with the money you were paying on the last two…ect. If you were to do this with the one with the highest interest rate instead of being concerned with the amount of the balances it might take longer.
This is called debt stacking and it works amazingly well. It allows you to pay off your debt faster than just spreading your extra money over several different cards. On average you can get about 10 credit cards with up to 30k balances paid off in 3 years using this plan.
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Used debt stacking and it worked!
Howdy, I answered this question for you at http://www.coddleshell.com – my own personal finance blog. I’ve pasted the answer below, I hope it helps!
Good question, you shouldn’t feel so bad about not knowing what is what when it comes to credit cards. They can be a dangerous tool as I’m sure you are now finding out. You’re right on with trying to reduce debt, starting with the highest intrest rate and working yourself down.
Both rates, the annual percentage rate (APR) and the effective interest rate (EIR) are both the same rates. Confused? So is the majority of everyone else.
An APR is a way to standardize and compare interest rates among lenders. It is an annualized rate that takes into account the total cost of borrowing. It is intended to standardize rates, as stated before.
The EIR is the rate you’re paying compounded X number of times per year, usually 12. Compounding means that every month, your balance is averaged (depending on the card and terms and conditions) and that amount is used to calculate the finance charges next month.
The other interest rates are probably rates like balance transfer or cash advances, etc. Don’t worry about those when comparing the cards.
To answer your question, in terms of comparing to another card, you should use the APR. The card with the highest APR should be paid off first, repeat this until you’ve got it all paid off.
References :
On the bottom of your statement it should have a section where it breaks down the interest by Purchases etc. Look at that interest rate.
Working on the highest balance or the highest rate can slow you down at times. Debt stacking does work really well.
Sometimes you can get a "deal" on transferring your balance to a different card. I know, it doesn’t make it go away. But, by transferring off a high interest card to a 0% or a low %, it will help you shovel yourself out of the hole faster. BEWARE transfer fees, time limits, having too many cards open, etc. Always put the money you are "saving" toward paying off a card.
Also consider non-monetary things like customer service. Some Card companies will work with you to lower your interest rate – call and ask.
Some good articles & calculators on the The American Institute of Certified Public Accountants website:
http://www.360financialliteracy.org/Financial+Topics/Personal+Finance/
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The people above have done a good job answering the interest question. As far as paying them down I would try to pay down the largest balance with the highest interest rate. Thats money that could be going elsewhere. If you can find a card that would give you 0% for a year than try and switch the balance. You do need to pay attention to see if there are transaction fees.
My wife had 10K in debt and we got it switched to 0% card 3 consecutive years, and she saved almost 5,000 in interest fees. I told her that was as good as making 5,000 in the stock market. It takes time, I’m sure it took time to get in debt. Don’t feel bad, you are not the only one in the same boat.
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