Dubai: It’s common to carry multiple credit cards, but how do you manage your monthly payments on all of them? If you’re only paying attention to the total amount you owe when looking at your credit card bills, you’re likely not getting far in eliminating your debt.
A number of surveys conducted among million-plus credit card holders worldwide who use more than one card and don’t pay off their entire balance every month, it was found that people overwhelmingly choose ineffective strategies for paying off their debt. Here’s an example.
Let’s say you owe Dh10,000 on one card and Dh5,000 on another and both the cards have a total of Dh1,500 to put toward both cards in a given month. Chances are you will pay down Dh1,000 on the larger card and Dh500 on the smaller one, regardless of what the interest rates are.
Balance-matching’ is better than only making the minimum payment, but it still caused debtors to rack up a substantial amount of interest
Making payments proportional to balances owed on each card is what is referred to as ‘balance-matching’. “‘Balance-matching’ is better than only making the minimum payment, but it still caused debtors to rack up a substantial amount of interest,” said Mirin Raul, a Dubai-based debt advisor.
“Many people carry credit cards that charge varying amounts of interest, but it is considered suboptimal when you apportion payments based on how much you owe, no matter how many credits cards you carry, or how much you owe on each one.”
How then should you pay multiple credit card balances?
Instead of matching the share of repayments on each card to the share of balances on each card, you would be better placed if you put most of your repayments toward the higher interest card. To understand this better, let’s go back to the earlier example.
Let’s now assume the first credit card (‘Card A’) charges 18 per cent interest and the second credit card (‘Card B’) charges 12 per cent. The cost-effective solution is to apply the minimum amount to Card B as it charges lower interest, and then apply the rest of your payment to Card A.
The sooner you pay off Card A, the better, since that higher interest rate means an increasing accumulation of debt. “Prioritising high-interest debt over low-interest debt, regardless of how much you owe on each, will help you incur the least possible interest and save more,” Raul added.
Understanding how you repay your revolving debt can help you develop techniques that will reduce your overall debt burden more quickly
“Understanding how you repay your revolving debt, i.e. the balance you carry forward each time you don’t pay your credit card balance in full, can help you develop techniques that will reduce your overall debt burden more quickly.”
So, simply put, by paying off the card with the highest interest rate first, you'll save more money over time. You'll also decrease your debt faster since the interest fees will decrease as your debt decreases.
How to calculate which credit card to pay off first
In order to calculate which credit card to pay off first, you need to locate each card's interest rate by looking at your credit card statements. Next to each card's annual percentage rate (APR), list the card's current balance.
“By listing out sand categorising your credit cards according to their interest rates, you can calculate which credit card may rack up the most (and least!) interest over time. This may help you in deciding which debt method might work for you,” said Andrea Barber, an Abu Dhabi-based financial planner.
“Next, pay off your highest rate credit card, and then add that first card's monthly payment amount to the minimum payment due on the next card in line, to determine its monthly payment amount. Pay that off and repeat, until you've reduced all of your credit card balances to zero.”
When budgeting what you can afford to pay off credit cards, assume you will only make minimum payments against your balances and then work out the rest of your budget
Barber further explains that the next step then is to add up all of your monthly bills and money for necessities, including the minimum payments due on all of your cards, followed by determining how much cash you have left over that you can dedicate to debt repayment.
“When budgeting what you can afford to pay off credit cards, assume you will only make minimum payments against your balances and then work out the rest of your budget. Once you find out how much you can put towards your credit card debt, you can build a working strategy,” she added.
Bottom line?
High credit card interest rates will multiply what you owe. By prioritising high-interest credit card debt will rid you of your balances slightly quicker than paying low debts amounts first. But apart from that, what more do you need to keep in mind when working to reduce your credit card debt?
“You need to be mindful of how often you use your card and commit to paying your balance off each month to prevent interest from accruing. Likewise, if you need to continue using credit, use your lowest rate card for purchases,” added Barber.
“Additionally, as your cards are paid off, keep them open if their fees are minimal and if you are not planning on using the card to accumulate debt again. If you do choose to close the account, consider only doing so after you have monitored the balance and your credit score for a few months.”
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