Interviewed at Reviewed about our research in the Journal of Consumer Research about repayment concentration and motivation.
Credit card debt is overwhelming, and as interest stacks up, bringing down your balances can seem impossible. The average American household has more than $6,000 in credit card debt, and may face interest rates as high as 25%.
While the approach you choose for a debt-free future depends on your individual situation, the first steps are the same.
“Your minimum payments are roughly around 2% of your balances, and missing these will hurt your credit score,” says Simon Blanchard, an associate professor of marketing at the McDonough School of Business at Georgetown University in Washington, D.C.
With that in mind, here’s some advice to weigh your options and bring down your balances once and for all—with a little guidance from research.
Debt consolidation is a viable option, especially if you’re overwhelmed by keeping track of multiple accounts. People who’ve lost their jobs might consider a personal loan, as they usually have much lower interest rates than credit cards, and we'll explore balance transfers in a bit. This strategy, however, will leave you with one mountain of debt to tackle.
“Because it puts everything into a massive account, it can look really daunting and that can potentially decrease your motivation,” Blanchard explains. But according to a 2016 study that he co-authored in the Journal of Consumer Research, there is one way to increase your motivation.
Blanchard and his colleagues looked into spreading payments across multiple debts, or devoting most of your money to one account at a time. "How you allocate your debt matters in terms of how much motivation you'll have," he says. “What we found is that those who were following a concentrated strategy worked 15% harder and got out of debt faster." Two approaches—the avalanche and snowball methods—might provide some extra inspiration.
This strategy prioritizes paying off debts with higher interest rates first while still making the minimum payments on any other accounts. Blanchard explains that this is the most cost-effective method, as it minimizes the total amount of interest you pay.
It could be particularly successful for you if your budget is already stretched thin, or you’re numbers-driven. But there are a few downsides to keep in mind.
If your card with the highest interest rate also has the largest balance, it's not incredibly motivating when that balance doesn’t seem to go down. According to Blanchard, there’s the possibility that you won’t internalize this slow but steady progress.
If your card with the highest interest rate also has the largest balance, it's not incredibly motivating when that balance doesn’t seem to go down.
Feeling discouraged could get in the way of sticking to your repayment plan. In this case, you might be better off with more tangible results, which we’ll get into next.
A popular approach to paying down credit card debt, the snowball method involves paying off your accounts one by one, from the smallest balance to the largest, while still making the minimum payments on each one.
Let’s look at how these methods differ with these credit card balances:
With the avalanche method, you’d first focus on paying off credit card No. 1, as it has the highest interest rate. Following the snowball method, you’d start with credit card No. 2, as it has the smallest balance. Remember: In either scenario, you’d make the minimum monthly payments on the other two accounts to avoid hurting your credit score.
If you break down the numbers, the snowball method can end up costing you more money in the long run. As you devote more money to smaller accounts, larger debts with high interest rates will rack up charges.
But there is an upside to the snowball method. You’ll pay off smaller balances relatively fast, which makes you feel like you’re making progress. Because of this, you might adopt other healthier financial habits, from picking up an extra shift at work to taking on a side hustle or cutting your living expenses. That means you’ll have even more money in your pocket to put toward your debt, and it'll be off your plate sooner.
If you're up against particularly high APRs, there's another type of debt consolidation you might consider: a balance transfer. A credit card with an introductory 0% interest rate is a potential solution only if you’re sure you can pay off the transferred debt before the promotional period ends. Otherwise, you could find yourself back in the same, or an even worse, situation—hit with a very high interest rate that is usually applied retroactively to your initial balance.
Although there are credit cards that do not charge a balance transfer fee, read the fine print. Many incur a fee of 3% of the amount transferred.
Blanchard recommends setting calendar reminders so that you’re aware when the standard APR is about to kick in. And be wary of maxing out these cards. Even if you’re making on-time payments, he reminds that a high credit utilization ratio is detrimental.
“Anything that hurts your credit score will hurt your future ability to get other personal loans, refinance your mortgage, etc.,” Blanchard says. “Having revolving credit card debt should ultimately be a last resort.”
During the coronavirus pandemic, many Americans are dealing with additional financial strain. “Pre-COVID, 37% of American households would revolve on a credit card payment at least once a year, according to the National Foundation for Credit Counseling,” Blanchard says. “This means that when these people do have debt, they tend to generate a fair amount of interest, around $1,000 or $2,000 a year.”
Blanchard encourages consumers to look at resources that are available during this time. Many credit card issuers offer promotional interest rates for new or existing customers. Right now, some may be willing to provide assistance at an individual level, perhaps by offering a lower minimum payment or interest rate.
In many cases, this may not be advertised on websites. So it could be in your best interest to pick up the phone and contact customer service. Be clear about whether deferred payments could result in a request for a large balloon payment in the end, rather than simply restarting regular payments.
There are multiple options when it comes to tackling your debt; you have to choose the best method for your individual financial situation. Whatever your approach, always make your minimum payments. And remember that progress, however small it seems, is still progress. Chipping away at debt little by little will help you avoid building up more interest, and prevent your credit score from taking a hit.