Paying Off Outstanding Credit Card Balances

What is your outstanding balance?

Your outstanding balance is the amount of money you owe on your credit card, including accumulated interest and new purchases. Your monthly payment is credited toward your outstanding balance. If you make only the minimum payment, however, most of your money will go toward the finance charges without greatly reducing the principal balance.

What is the best strategy for paying off your outstanding balance?

There are several strategies for keeping your credit card debt under control and eliminating the balance. Some of these are discussed in the following sections.

Lump-sum payoff
You may receive a substantial windfall, such as an inheritance, an employment bonus, or lottery winnings. You can use this money to pay off your credit card debt. This is typically a better use for your windfall money than investing it, since you'd need an investment with an after-tax rate of return of at least 18% to cover the cost of your credit card debt, in many cases.

Prioritizing repayment
The next best strategy is to stop using your credit cards and put as much money as possible toward reducing your credit card debt. You can rank the cards according to their interest rates and then systematically pay off your debt, sending the largest payment possible to the most expensive card. Make sure this payment exceeds the required minimum payment, since every additional dollar you pay decreases the amount of interest charged on your balance. Continue making just the minimum payment on your other cards until the most expensive card is paid off. You can then focus your repayment efforts on the next most expensive card.

Balance transfer
You can use credit cards with lower rates to pay off the higher rate cards. The money you've saved in interest can then be applied to your outstanding balance. The next time you're offered a lower rate credit card, read the conditions. If the new card's credit limit is high enough to pay off the older, more expensive card, make the transfer.

Caution: Some cards have acceleration charges that might let the issuer demand payment in full if it sees you are closing the account using another card.

Use an interest-reduction strategy to make payments on high interest cards
In limited situations, it may make sense to use one card to make payments on another. If you have a card with an outrageously high interest rate and a high outstanding balance, you may not be able to get a new card with a high enough credit limit to transfer the entire balance. You may, however, be able to lower your interest costs somewhat by using a cash advance from a lower interest card to make payments on the higher interest card.

Caution: This strategy should be considered only as a last resort. Do not continue using the high interest card while you are paying it off. Close the high interest account immediately upon reaching a zero balance.

How fast do credit card companies have to process your payment?

The credit card company has to credit your account the day it receives your payment, provided you've followed proper payment procedures. If you haven't signed your check or have transposed two numbers on your account, your payment may not be credited as quickly. You also have the right to request a refund if your account has a credit balance of more than $1.00. The bank or financial institution must send you the money within seven days of receiving your request. If a credit balance remains on your account for more than six months, they are required to make a good faith effort to find you.

Is there ever a time when you should pay off a lower interest card first?

Psychologically, it may be reinforcing to eliminate a debt completely, especially if the balance is small. If you like incentives, pay a small card first, regardless of its interest rate. Once the card is paid off, close the account. This will eliminate the temptation to make additional charges, and it will get rid of the clutter on your credit report.

Think carefully before using the equity in your home to pay off your credit cards

If your credit card balance grows large enough, you may be tempted to tap into your home equity to pay it off. The interest rate on a home equity loan or line of credit is likely to be lower than your credit card, and it is generally tax deductible. Keep in mind, however, that getting a home equity loan or line of credit means putting your house at risk. If you fail to make the payments on your loan, the lender can foreclose and use the proceeds to pay off your loan. In addition, if you use a home equity loan or line of credit, you could be making payments on your credit card purchases for a long time to come--often as long as 30 years.

Don't hold on to cards you're not using

You may think it's a good idea to have lots of available credit, just in case you ever need it. But from a lender's point of view, lots of available credit means lots of potential trouble. The more credit you have available, the greater the chances you'll get in over your head. Even if you never use the cards, open credit accounts can damage your chances of getting a mortgage or other loan in the future. Proper card use demands that you cut up cards you don't want, return them to the issuer, and not accept renewal cards you don't plan to use.

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