My goal for the New Year is to wipe out the balance on my two credit cards and be debt free. Could you recommend a strategy for doing this? One card has a $2,000 balance and the other has roughly $1,000 on it. Both were used for school expenses. Should I transfer one card balance to the other, which has a lower Annual Percentage Rate (APR), and work from there?
"You have a noble goal in mind," said FPA member William J. Taylor, CFP®, Vice President & Senior Trust Officer, at The Farmers and Mechanics Bank. "Our recent national financial troubles would be less if more people would have had a goal like yours — to be out of debt as quickly as possible."
With the understanding that complete data has not been gathered, alternatives have not been considered and a financial planning engagement has not been established, Taylor offered the following guidance:
"You are on the right track as you consider moving the balance with the higher APR to the card with the lower rate. However, before making this change, be sure you are aware of the fees associated with the card with the lower ARP. It's possible that there could be a higher interest rate for balance transfers. Some cards are able to sharply increase rates with transfers. If your card has this option, any advantage to the transfer may be lost and possibly make the situation more expensive.
"Regardless of whether you can make the transfer to the card with the lower APR, having a budget will be very helpful to you in the coming months. As the first step in becoming debt free, you should have a firm understanding of where your income is spent. Since these credit card balances are from education only, you must be you must be consistently living within your means on a day to day basis, which is also very commendable.
"The budget will help you see how your money is spent and then you can decide where you can make some changes. It is important that you have some funds set aside as an emergency fund to meet unexpected expenses or if your income is reduced or eliminated. This fund is to handle out of the ordinary demands for money that would have to be placed on the credit card. Any savings of more than three to five months of expenses can be used to reduce the credit card balance.
"Consulting the budget, you will then have to determine which expenses can be reduced to allow for additional payments to the credit cards. If two cards remain, focus on paying off the higher interest rate card first and then attack the second. If you have $3,000 of debt with monthly interest, you will have to pay more than $300 per month from March to December to accomplish your goal. So you will need to determine where in your budget you can reduce expenses or increase income to meet this obligation. Any expense cut should not create additional costs such as late fees or interest.
"Do not let either card payment be late, even if only paying the minimum. The goal of a high credit rating can be achieved by paying off debt and never being late on a payment. Most likely, sacrifices will have to be made in your current standard of living to pay off the cards. However, it will be worth it. Once your debts are paid off, you can perhaps use the payments to improve savings. With improved savings, future debt can be reduced as cash is used rather than credit. You will be on the way to true financial independence.
"Your goal of quickly paying off the debt is the first sign of successful money management."