Introduction
When you have multiple credit card accounts, it can take effort to figure out which balance to pay first. Fortunately, an algorithm helps credit card companies decide which bills to pay first.
If you pay only the minimum, that money goes toward the balance with the lowest APR.
If you pay only the minimum, that money goes toward the balance with the lowest APR. This means it will likely be applied to your highest interest-rate debt first.
Your credit card company will pay off both debts according to their terms if you have multiple secured accounts, such as a credit card and a car loan. For example:
- A credit card has an APR of 15 percent and a $0 minimum payment due each month
- A car loan has an APR of 5 percent with a $200 monthly payment
- Interest rates on your balances stay the same until your next billing cycle
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You can determine which balance to pay first by hand.
You can also determine which balance to pay first by hand. This is simpler, but it requires more time. You’ll need to find the balance with the lowest APR (annual percentage rate) on which you want to make your initial payment.
That’s a bit of a mouthful, so let’s look at an example: say you have three credit cards that charge 15%, 11%, and 8%. If you only paid minimum payments of $100 each month on all three debts, they would be paid off in this order: 11%, 8%, 15%. However, if instead of paying minimums on all three debts, you spend $200/month total toward whichever one has the highest interest rate (in this case, 15%), then that debt will be paid off first.
First, you’ll find the balance with the lowest annual percentage rate (APR) or “go-to rate.”
To determine which debt to pay first, credit card companies look at your APR. The lower the APR, the better.
The logic behind this is simple: If you have two debts with similar balances and payments, but one has a lower interest rate than another, it makes sense to pay down the loan with the higher interest rate first.
You can calculate your lowest go-to rate by finding out what’s called your “directional loss”: if you don’t make a payment on one of your cards and leave it alone for several months or years before making any efforts to pay down that balance (and thus accruing additional interest), what will happen?
The minimum payment is calculated based on your total balance, penalty APR and any fees.
The minimum payment is calculated based on your total balance, penalty APR and any fees.
The first step in calculating your minimum payment is determining the days between when a bill was generated or sent (usually 21 days) and when it’s due. The next step is multiplying the total balance by that number and dividing it by 360 (the number of days in one year). This gives you an approximate amount for what you should pay toward your balance each month without paying anything toward interest charges or penalty APRs
Your minimum payment is made up of two parts: interest charges and a fixed portion of your principal balance.
The minimum payment is the minimum amount you must pay monthly to avoid late fees. This combines two parts: interest charges and a fixed portion of your principal balance.
The first part, interest charges, is calculated based on the interest rate and your balance. The second part, principal reduction, refers to any money put toward paying your credit before it’s due.
You owe $100 on your credit card bill at 18% APR (annual percentage rate). If you paid $50 per month towards that bill right away–before making any purchases with it–you’d only spend about one-seventh of what was initially charged in interest each month: $17 instead of $34!
The interest rates on your balances stay the same until your next billing cycle.
The interest rates on your balances stay the same until your next billing cycle. So, if you’re paying off two different credit cards with a higher APR than the other, that card will be paid off first.
The annual percentage rate (APR) is the interest rate you pay each year on your credit card debt. The APR is calculated by dividing the annual interest rate by 12.
For example: If your card has a 20% APR and you charge $1,000 to it at the start of May, then by December 31st, that $1,000 would have cost you $120 in interest charges ($120 = 20% x 6 months).
Minimum payments are calculated based on your total balance, penalty APR and any fees.
Your minimum payments are calculated based on your total balance, penalty APR and any fees.
For example, say you have a credit card with a $10,000 balance and an APR of 29%. If that same card has a late fee of $50 and a finance charge of 3%, then your minimum payment would be:
$10,000 x .29 = $2,900 (the base amount)
plus:
$50 (the late fee) + $3 (.06 * 10k) = $53 (credit line used during the billing cycle) + $3 (.06 * 10k) = $56 (amount owed before a finance charge is applied to the account). In this case, it would equal about 1/3rd of what was paid last month or 26-28% of their monthly bill.
Know how payment works so you can optimize how much money you pay
- Make a payment.
- Pay more than the minimum.
- Understand what happens when you don’t pay at all.
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Conclusion
So, to sum it up, if you want to pay more than the minimum on your credit card bills, it’s essential to know how much you can expect to pay each month. This will help you track which bills might be paid off first and thus make it easier for you when making future budget plans.
