How do you manage your credit card debt if you carry a balance from month to month? Do you pay off the smallest debt first, or the debt with the highest balance? If your plan of attack involves the former then you may be doing yourself a disservice—at least according to a recent study on the subject.
The survey, which was recently published in the Journal of Marketing Research, attempts to debunk the commonly held notion that those with debt should eliminate it by paying down their smaller debts first.
The inclination of consumers to do this is dubbed “debt account aversion”—which is an emotional, as opposed to rational, approach consumers have to debt reduction. Why consumers and some financial advisors think this way is still up for debate, though the paper hopes that banks, credit unions and policymakers work to get a better understanding of this to help consumers in debt get on the right track.
The average U.S. consumer has five credit cards that carry about $1,000 or more per account while credit card debt in the U.S. reached an all-time high rate of $976 billion in 2008, according to the study.
“There are a variety of ways to manage debt, many of which are not optimal,” said one of the study’s authors, Scott Rick, said in a statement. “One strategy we didn’t see a lot of was the rational one, where you pay off the account with the highest interest rate. We tried to be very explicit in the instructions and showed participants what was happening over time with the high-interest account blowing up. But despite this seeming simplicity, emotions drive us to wipe a debt off the books.”
Pay It Down The Right Way
More than a third of credit card holders don’t know the interest they pay on their credit cards according to information from the Federal Reserve Bank of Boston. Taking control of the interest you pay on your credit card is crucial to successfully paying off your credit card debt, so make sure to check your monthly statement for this and other information pertinent to your account. Try to avoid penalty rates by making timely payments and, if possible, negotiate with your credit card company to secure the lowest possible rate.
If you have available credit on a credit card with a lower APR consider making a balance transfer. Be sure to check if there is a balance transfer fee so you aren’t paying more than you need.
Above all, don’t waste your money paying off smaller debts if it’s costing you more. If you can’t pay off your credit card debt in full each month then tackle your higher interest debt first to save more cash over the long haul.