When paying down credit card debt, Americans traditionally choose one of two strategies.
The first is the “snowball” method, in which you pay off the liabilities with the smallest balances first. The logic goes like this: Once you experience the satisfaction of paying off debt, however incrementally, you see the light at the end of the tunnel and you become motivated to pay off even more. Keeping interest rates in mind, debt payments “snowball” until it’s all paid off.
An even better strategy focuses on high-interest payments, in which you pay off the debt with the highest interest rate first. As personal finance expert LaTisha Styles puts it: “It will take you longer to zero out that debt, but over the long run, it’s going to be cheaper.”
Why? Because you’re paying more in principal and less in interest over the long haul.
But many Americans are now forgoing these two options—which remain the most effective debt repayment strategies—for something called balance-matching. This involves allocating your payments according to the size of the debt, no matter the interest rate.
According to the National Bureau of Economic Research (NBER), most credit card debtors now tend to react based on the size of the balance of each card. More of the payment is applied to the largest balance, without taking into account the principal vs. interest ratio. This strategy also fails to take into account the “snowball” effect, whereby positive reinforcement eases the repayment process.
Stay away from balance-matching! If you ignore interest rates, you will waste hundreds or even thousands of dollars repaying your credit card debt.