You need a strategy for paying off those credit cards.  There is but one strategy, snowballing.  This method takes a set amount of money and applies it across all debts, paying all minimums with the remainder going to one particular debt.  There are several possible orders in which to approach this.

1. Order them from highest interest to lowest interest, focusing on the highest interest first. Paying them off in this order will minimize the interest you pay.
2. Order them from lowest balance to highest balance, focusing on the lowest balance first. You’ll gain a sense of achievement as each balance goes away and the next one accelerates when you shift those original payments to it.
3. Order them from highest balance to lowest balance, focusing on the highest balance first. This method will give you a greater sense of achievement as balances are paid off, BUT you may continue to feel hopeless since it will take longer to get rid of the balances.
4. Order them from lowest rate to highest rate, focusing on the lowest rate first. This is similar to number 2, since more of your payment is going towards principle. With this strategy you may want to consider doing a balance transfer to the lowest rate card from the highest rate card, thus combining it with number 1.
5. Order them by “duration until payoff.”  This is done by taking the current principle plus accrued interest and dividing by the current minimum payment.  This method may result in one of the previous four methods, but this is not necessarily so.  You would focus your efforts on the debt with the lowest duration.  This will most likely result in a faster sense of achievement than number 2, since the lowest balance may not have the fastest payoff.
6. Order them in the order you want to pay them off, focusing on what’s most important to you. This is a great way to do it if you include other loans, such as a loan from a friend. You’ll receive a similar result to number 2.

After you decide the order you are going to attack your debt, you need to decide whether you want to use standard or reverse (my term) snowballing.  In standard snowballing, you fix the current minimum payments and use them as the minimum amount paid each month.  Reverse snowballing can result in paying the first loan off faster, since you fix the total amount paid and apply the remainder after current minimums to your first loan.

Now that you know about snowballing, stay tuned for pairwise comparisons of the various methods mentioned above.

Did you know that most credit card companies define your minimum payment as finance charges + over-the-limit & late fees + a percentage of the principle?  If you were to pay just the minimum due each month, you would spend the rest of your life paying off these bills.

For example, if you have a credit card with a $7500 balance, 17% APR and 2.5 % of principle payment, you would be paying for 329 months (assuming no late fees and no additional charges), that’s just over 27 YEARS.  The initial minimum on this is $187.50.  Now if you were to take this initial amount and fix it, you can cut this down to only 60 months, or 5 YEARS, an 81% reduction in time.  So go back to your budget and make sure that the highest minimum payments you have made recently are set as your payment levels for each card.  This will help you maintain your budget.

Later today, I will post about various approaches to debt repayment as part 2 of this series.

Monday I discussed the future value of money, given a known principal, interest and time.  This is all well and good, but what happens if you want to have a certain amount within a specified time at a known interest?

For today, we’ll say that you want to have a $5,000 emergency fund in 18 months and you will be putting the money into a savings account earning 5%.

Now, just like Monday, you have the same two options, either put the initial principal in once, or add it as an annuity.

For a single deposit, use this equation:

For an annuity, use this equation:

So, how much do we have to put in to achieve our goal?

For a single deposit, we need to deposit only $4639.44, but for an annuity, we’d have to deposit $268.07 per month for a grand total of $4,825.25.

At this point, we’ve investigated the future value of money in terms of a fixed total going in, and a fixed future value.  It would appear from these two cases that annuities are a weaker choice given a fixed period and rate for both a fixed input and a fixed output, but what about when period or rate becomes the variable?  

We shall see what happens with these two as variables in the next two posts (tomorrow and Friday), finishing up the week (Saturday) with a complex example.