With respect to paying off credit card debt, one school of thought is that credit cards with higher interest rates should be paid off first while the other school of thought suggests paying off those with the lowest balances first – sometimes referred to as the snowball method – is the way to go.
From a purely financial perspective, the former is the better approach. However, there is value in the latter approach as there is a psychological lift – a real sense of progress – from paying off one card and then committing the money that was being paid on the first to the next card in line, continuing this progression until the last card is paid off. This was the approach the wife and I employed when eliminating our credit card debt and it worked well for us.
Dave Ramsey, perhaps the best known advocate for this method, describes the process as such: Pay minimum payments on all of the debts except the smallest one then attack that debt with a vengeance. We’re talking gazelle intense, sell-out, get-this-thing-out-of-my-life-forever energy. Once it’s gone, take the money you were putting toward that debt, plus any extra money you find, and attack the next debt on the list. Once it’s gone, take that combined payment and go to the next debt. Knock them out one by one.
Celebrate Being Debt Free With Some Snowball Cookies
Whichever method you use, the key is to stop using the credit cards and stay committed to reducing the balances to zero while you start working your savings and investment plan.
That last point brings us to another case of differing schools of thought. One philosophy suggests that credit card debt should be paid off completely prior to committing money to investing. My belief is that while credit card debt should be under control and be on a steady decline, it does not necessarily need to be paid off completely before you develop a savings and investment plan and begin committing money to your retirement accounts.
My rationale is that the sooner you establish your savings and investment accounts, get in the habit of funding them, and get in the habit of managing them the better off you will be; the sooner you can make your money start working for you through the power of compound interest.