Ask Money

Paying off credit card

Chris Farrell Mar 11, 2010

Question: I am trying to pay off my credit card. However, the interest rate is so high (%17.9) that it’s really hard to get ahead. I owe &7,000 and never use the card anymore. My minimum payment is around $190 a month which is basically ALL interest.

I spoke with a card representative over the phone. They tell me there are no other offers available right now for a lower rate. They told me my other option was to do what they called a “Pay Down.” They would close my card and allow me to pay a certain amount every month for 60 months with no interest to pay off the card. Would enrolling in this type of pay-down program and closing my card affect my credit score? If so, do you have any other suggestions for paying the card down? Any advice would be greatly appreciated. Thanks, Beth, Newburgh, IN

Answer: A former boss of mine once quipped that the real definition of personal finance was getting out of credit card debt. Sad to say, for many folks he’s right. I wish there was a magic formula for eliminating credit card debt and reducing household stress. There isn’t. But there are time-tested solutions that work. What I want to do is lay out one way of thinking through your decision.

I went to the Federal Reserve’s credit card calculator to run some numbers. You’re carrying a balance of $7,000 at an interest rate of 17.9%. According to the Fed, it would take you 40 years and interest charges of $18,457 if you kept on making the minimum payment each month. (The calculator puts the initial minimum payment at $140.) You can check out the calculator here.

That’s a scary number. The bank pay down plan over 5 years looks terrific in comparison.

But let’s run some more numbers before you take the deal. We’ll go back to the Fed calculator and this time you’re going to pay $200 a month. The trick is to keep on sending $200 a month even though the required minimum payment will shrink with time. You ignore that lower minimum charge. By maintaining a $200 a month payment you could eliminate the debt in 4 years and fork over $2,974 in interest charges. That’s not great, but it’s a lot better than 4 decades and more than $18,000 in interest. Send in a consistent $350 a month and the debt’s gone in 3 years and $2,131 in interest; a $300 monthly payment, and its 2 years and $1,668 in interest. Of course, the numbers get better the more you put toward the debt, but the figures are also unrealistic.

Small steps add up over time. You can learn about tricks of the debt reduction trade by checking out the e-book, Reduce Debt, Reduce Stress by Gerri Detweiler, Nancy Castelman and Marc Eisenson. (You can look at it on their website.) They’re veterans of the getting-out-of-consumer-debt movement. They really know their stuff and the advice is extremely practical.

So, one question is whether you can find another $25 to $100 a month to go toward the credit card debt with budgeting. You can then weigh that option against the bank’s modification plan. The price there is a closed account. The deal could tarnish your credit report and hurt your credit score. But if after running the numbers and weighing your choices it turns out the only way to get out of from under the $7,000 bill is the bank Pay Down plan, I’d take it.

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