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Author: ltcomdata One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 308782  
Subject: best payment method Date: 11/16/2000 10:01 PM
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Hello...

I am a student and get minimal financial aid... So I guess I have been using credit cards a lot to meet those tuition hikes... I, however, am proud to say that over the course of 5.5 years of school, only owe about $5,000.00---which is less than the average student owes after about the same amount of time. Now the bad news... The debt is distrubuted over NOT 1, NOT 2, NOT EVEN 3, BUT 4 CREDIT CARDS with varying interest rates ranging from 14% to 21%. Needless to say the card at 14% is maxed out except for 100, which I am afraid to use up in fear that I might look desperate to my creditors :-). I also have a 5th card with a $200.00 limit that I use from day to day but which I pay in full at the end of the month... I know, I am trying not to use it as much, but I find that IF I use it and pay in full at the end of the month, that I get some extra money "float" in my interest bearing checking account... Basically, I see this card as an interest free loan which I use to get interest at my bank (the revenge of the consumer!! lol)...

Anyway, I was wondering what would be the best method for payment... What is this snowball method of payment that I hear so much about in this board?

I devised a method of payment that I think is sound, please let me know what you think of it... It is based on the assumption that I want to minimize, NOT the interest that I get charged, but the total amount of money that I get charged by all the credit cards combined... I devised my plan based in the follwoing scenario:

Having two cards, one with a debt of 10,000 at an interest rate of 10% (per month, to make it easy) and another with a debt of 1,000 at an interest rate of 20% (per month, to make it easy). Suppose that you have 100 dollars extra left after paying the minimums in the cards. Conventional wisdom would be to pay it all to the card with the higher interest rate, reducing the debt to 900, while leaving the other debt as it is (remember the minimum was already payed). The next month I would owe, respectively: 11,000 at 20% and 1,080 at 20%. The problem that I saw with this scenario is that while the bigger card had the smaller rate, since it was so much bigger than the smaller card, it accumulated more debt more quickly. I accumulated a debt of 1,000 on the bigger card (which will compound even more quickly because I will pay only the minimum on that account until I finish paying off the smaller card) whereas I was charged 180 in the smaller card. Assuming that I have 100 extra each month to pay off debt, I will be chipping away at the smaller card, YES, BUT I will not be chipping away at the big debt, which will only get bigger, even though it has a smaller rate.

So, my plan is teh following...

Pay a set amount of money, say 200 each month no matter what (well, unless you are in a death-life situation and need the money to get the medical treatment of the brain operation you are about to have...).

Pay the monthly minimum first...

Then, with the extra money left, I will pay some portion to the big card, and some portion to the small card... an the portion will be determined as follows... Since the money that gets added to the debt is interest*principal, I will work with those numbers instead of working with interest or principal only. I want to know just how much bigger is my debt with the bigger card... I sort of need to to know how much money is getting added to the debt in percentage points... So I calculate that as follows (A denotes card A and B denotes card B; I=interest; P=principal):

(IA*PA)/(IA*PA + IB*PB) = QA = percentage debt being added by card A

(IB*PB)/(IA*PA + IB*PB) = QB = percentage debt being added by card B

Actually, they are not quite percentages because I have not multiplied by 100, they are ratios of debt instead of percentages of debt, but that's a fine point.

Now to the fun part. Whatever extra money I have left after paying the monthly minimum (say it's X) I multiply for the ratios that I just calculated above, and then i add the minimum to get what I will pay that month for each credit card:

X*QA + minimum A = payment A
X*QB + minimum B = payment B

I run out of time, so I cannot continue with how this formula will affect my example, so I have to leave... But you get the idea... Let me know what you think of my method... and whether there is a better one available... or whether my mathod is seriously flawed in some way....

So... Thank you and bye...

Hoping to be debt free in 2 years....


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Author: Bweaver Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 49606 of 308782
Subject: Re: best payment method Date: 11/16/2000 10:38 PM
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Let me know what you think of my method... and whether there is a better one available... or whether my mathod is seriously flawed in some way....

So... Thank you and bye...

Hoping to be debt free in 2 years....


ltcomdata,

You've given this more thought that my math skills will allow. Congratuations on having a plan AND a debt freedom date!

Snowball: pay minimums on all but the card with the lowest balance, pay maximum affordable on lowest balance card. This accelerates the closing of a card, which increases cash flow for remaining cards. Wipe out the small debts quickly and the number of minimum payments required are reduced.

My preference: minimum payments on all but highest interest card, maximum payment to highest interest. This minimizes the amount of interest paid.

Your example may or may not work mathematically, but it assumes an urealistic level of interest that allows a balance to GROW while making minimum payments. Perhaps a more realistic test, using monthly interest rates, balances, and minimum payments comparable to your cards will shed more light on your question.

14% money is ALWAYS less expensive than 24% money. There's nothing wrong with attacking a larger balance first, but I think your example is tricking your into thinking your plan is a money-saver.

more realistic monthly interest example (assuming minimum payments reduce balance very little) might be:

3000 card at 1%
+30 interest
-50 minimum
2980

1000 card at 2%
+20 interest
-30 minimum
990

difference in next month's interest if an extra $100 is applied to either remaining balance:

990 interest v. 890 interest: (2%)
19.80 - 17.80 = Save $2.00

2980 interest v. 2880 interest: (1%)
29.80 - 28.80 = Save $1.00

Good luck,

Bruce



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Author: xtn Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 49608 of 308782
Subject: Re: best payment method Date: 11/16/2000 10:45 PM
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Mathmatically, it is better to pay towards the highest rate debt, regardless of balance.

Imagine for a moment this hypothetical situation. All your debt is on only one card, but certain amounts are being charged different rates. For example some cards charge one rate for purchases and a higher rate for transfers and cash advances.

Let us suppose that you have $4,000 on this card at 14% and another $1,000 at 18%. You would want your payment to be applied towards the money charging the highest rate first of course.

Well the fact that it is on adifferent card is no different. Paying off the highest rate card DOES produce the lowest total resulting amount of money you have to pay. You will save the most dollars this way in the end.

xtn


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Author: JABoa Big gold star, 5000 posts Feste Award Nominee! Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 49609 of 308782
Subject: Re: best payment method Date: 11/16/2000 11:42 PM
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xtn: You would want [emphasis applied] to have your payment applied towards the money charging the highest rate first of course.

Absolutely true, but the bank ain't Santa Claus. Therefore, if you have a single card with multiple rates, the bank will always apply payments to the lowest rate debt first. I am a nice person (at least my remaining friends say so) and even I would do that.

This of course does not detract in any way from xtn's main point about snowballing. It wasn't meant to, anyhow.

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Author: cypipes Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 49617 of 308782
Subject: Re: best payment method Date: 11/17/2000 10:23 AM
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Okay, I admit my math skills need work, but I've been considering another method.
I have a card with a smaller balance, but also a much lower interest than my HORRIBLE VISA Gold. What about putting the bigger chunk toward the smaller balance card to be able to transfer the money from the high balance card over to it - thus enabling the exit of the high balance card as soon as possible? Does this sound feasible?
- Cy

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Author: impolite Big gold star, 5000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 49619 of 308782
Subject: Re: best payment method Date: 11/17/2000 10:32 AM
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I have a card with a smaller balance, but also a much lower interest than my HORRIBLE VISA Gold. What about putting the bigger chunk toward the smaller balance card to be able to transfer the money from the high balance card over to it - thus enabling the exit of the high balance card as soon as possible? Does this sound feasible?
- Cy


Sounds like a great idea -- it's known around here as the balance transfer game. very fun to play, and if you do it right, you can beat the CC companies!

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Author: awldone Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 49638 of 308782
Subject: Re: best payment method Date: 11/17/2000 1:26 PM
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itcommdata said...

"...The next month I would owe, respectively: 11,000 at 20% and 1,080 at 20%. The problem that I saw with this scenario is that while the bigger card had the smaller rate, since it was so much bigger than the smaller card, it accumulated more debt more quickly. I accumulated a debt of 1,000 on the bigger card (which will compound even more quickly because I will pay only the minimum on that account until I finish paying off the smaller card) whereas I was charged 180 in the smaller card. Assuming that I have 100 extra each month to pay off debt, I will be chipping away at the smaller card, YES, BUT I will not be chipping away at the big debt, which will only get bigger, even though it has a smaller rate..."

you timeframe in the original post was a month, correct? so you have a cc that charges you 10% a month?! isn't it normally an ANNUAL percentage rate? as opposed to monthly? your math just scares me if it is a monthly rate and if i were you, i'd play the transfer game to get out of those cards.


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Author: SpeleoFool Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 49649 of 308782
Subject: Re: best payment method Date: 11/17/2000 3:02 PM
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I devised a method of payment that I think is sound, please let me know what you think of it... It is based on the assumption that I want to minimize, NOT the interest that I get charged, but the total amount of money that I get charged by all the credit cards combined...

Once upon a time I went down a similar path. I know what you're thinking--by focusing on how much interest you pay on one card, you affect how much accumulates on the other cards. There's some kind of strange interaction going on there, if you can just figure it out...

Fortunately, the math isn't really that complicated.

Forget about accounts and balances and payments for a second, and go back to the basics. Suppose you owe $5k total. Think of that $5k of debt as 5000 $1 dollar bills. Some of those $1 bills are subject to 14% interest, some to 21% interest. Left alone, a 14% bill will grow to $1.14 in a year, and a 21% bill will grow to $1.21. Obviously, given a dollar, it's wiser to pay off a 21% bill, even though that allows a 14% bill to grow freely.

The same holds true no matter how much you are able to pay to your debt. If you had $300 to pay each month, you'd be best off (mathematically) paying all $300 to the 21% card and nothing to the others. Since that's not a reality, however, you must make the minimum payment to the other cards and apply the leftover cash to the high-interest debt.

SpeleoFool.

Afterword, for the math geeks:

FWIW, there is a discrepancy that can arise when the minimum payment due on a lower-interest debt is a disproportionately large number. There may come a point where it make sense to quickly pay off that lower-interest debt in order to free up the minimum payment so that it may be applied to high-interest debt. If you need a dissertation topic, feel free to pursue those equations. Otherwise, rest assured that it rarely happens in the real world (particularly with credit cards, since the minimum payment tends to shrink with outstanding balance), and you probably couldn't save any appreciable amount of money by taking advantage of this quirk anyway.

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Author: mrbrolun One star, 50 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 49654 of 308782
Subject: Re: best payment method Date: 11/17/2000 4:11 PM
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I also have a 5th card with a $200.00 limit that I use from day to day but which I pay in full at the end of the month... I know, I am trying not to use it as much, but I find that IF I use it and pay in full at the end of the month, that I get some extra money "float" in my interest bearing checking account...


What bank are you using, if you don't mind my asking? Most I've run into have a substantial minimum balance requirement for interest-bearing checking - more than I'd be willing to put in a checking account when it could be better off elsewhere... (moot point, of course, as I have no money to invest).

But I wouldn't mind earning interest on the $1-2K I do keep in checking.

-Matt


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Author: ltcomdata One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 49659 of 308782
Subject: Re: best payment method Date: 11/17/2000 5:19 PM
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I use an online bank... Actually, I use a regular bank plus an online bank...

The regular bank (Bank One) does not charge me any fees whatsoever no matter what my balance is (as long as it is above 0) and I use the Banbk One's ATM's to deposit and take out money (If I go with a real life person, I get charged some fee). So instead I use the ATM's to put and take out money (have not had a problem yet). I use this bank because this way I can take advantage of the ATM's for free to either deposit money or take out money (Don't need to send deposits by mail). I deposit my paycheck every month into this bank.

The other bank I have is an internet bank called First Internet Bank of Indiana. They have absolutely no ATM's where I live (Chicago), but then agian I do not need them. They have a no-fee 5% APY interest bearing checking account (as long as you are confortable with banking online and receiving your statements online). No minimum balance to get interest, no minimum balance to avoid fees (again, as long as you are above 0). You do have to wait a while for your checks to arrive, but after that, you can beggin to write regular checks like a regular bank. They also have free online bill payment (which means that you do not have to spend money on stamps as long as you schedule your payments a week in advance). They also offer free on demand ACH transfers (after filling out the application you have to wait 2 weeks). You can put funds into the account by either mailing a check, direct deposit, or ACH transfers. So, what I do is: I deposit all my money in the regular bank's ATM's which are close to home (so that I do not have to send checks through the mail which would take longer and might be lost). Then I do an on-demand ACH transfer to the online bank (takes about 2 business days). After that, I start earning interest on that money. I pay my bills directly online using the online bill payment and specify the due date of the bill only; the online bank makes sure that the check is sent on time to pay the bill, but maximizing the amount of time that the money is in the account (whcih maximizes interest). I am very happy with the First Internet Bank of Indiana (www.firstib.com). You might want to check it out. There are other online banks out there that might give you a better intrest rate on your checking account, but they usually have higher minimum balances (which might not be a problem for you). Another very good deal is apparently www.pcbanker.com with no minimum balances and 6.25% APY on your checking account provided that your balance is less than 10,000.00. I am checking them out myself. To learn more about online banks, check out the online banking discussion board at http://boards.fool.com/Messages.asp?bid=100152



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Author: Klepley Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 70436 of 308782
Subject: Re: best payment method Date: 5/10/2001 4:50 PM
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Hello,
First, that is some great thinking. Unfortunately, I am lazy and prefer not to think (-: There are a couple sharware programs out there that really help you in analyzing and understanding the easiest way to pay off your debt Try them, putting in the different scenarios and it may become clearer as to the easiest way to pay off your debt.

One is Debt Analyzer and the other is Debt Freedom Calculator. The Debt Analyzer is an awesome program you should try first.

Good luck,
Kevin

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