A Little More Than the Minimum

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Carolyn writes in:

For the longest time, I’ve been making larger than minimum payments on all of my debts. I got the idea from Suze Orman because she said that if you just make minimum payments, you’ll never get rid of debt. I have two credit cards and a student loan. Here are their interest rates and outstanding balances and minimum payments:

Credit card 1 – 19.99% interest – $3,400 balance – $57 minimum payment
Credit card 2 – 15.99% interest – $4,000 balance – $55 minimum payment
Student loan – 6.75% interest – $41,000 balance – $470 minimum payment

What I’ve been doing is putting $700 in payments towards these debts each month, but I have been spreading out the extra among the loans. This means adding $39 to each payment, giving me a payment of $96 on the first card, $94 on the second card, and $509 on the student loan.

Is this the right way to go?

Suze is both right and wrong here. She’s absolutely correct in making the point that if you make just minimum payments on a debt, you’ll find it takes decades to fully pay it off. Even worse, the longer you take to pay off a debt, the more money you pay in just interest on your debt – it’s just money lost.

However, she’s not quite right on the idea that you should make larger-than-minimum payments on all debts.

According to my back-of-the-envelope math on the three debts you named, it will take about thirty years to pay off each credit card with just minimum payments, and just under ten years to wipe out that student loan with just minimum payments. If you use your alternate plans with a bit larger payments on each debt, you save about $6,000 in total interest, pay off each credit card in about five years, and pay off the student loan one year earlier. In other words, you’ll go another five years without eliminating any of the debts.

I agree with making overpayments, but I think you should channel all extra payments to the highest interest debt. In this case, that’s the credit card with the 19.99% rate. If you make a $117 extra payment on that debt each month, you’ll pay off that debt in a year and a half. At that point, you can apply a $174 extra payment (the $117 extra payment you were making, plus the $57 you were making on that first debt that’s now eliminated) on the second credit card, paying it off in about a year and a half. You can then apply a $229 extra payment each month to that student loan (the two minimum payments, plus the $117 in extra payments) and eliminate that student loan in about seven and a half years (total).

That simple shift will get you to debt freedom one and a half years earlier than before.

This is called a debt repayment plan, and the basic idea behind it works no matter how many debts you have or what type they are. You just order the debts by interest rate, make minimum payments on all of the debts, and make the biggest extra payment you can to the debt with the highest interest rate.

You may also want to do things like negotiate with your credit card companies for a lower rate. The worst thing they can do is lock your account, which doesn’t matter a bit if you’re not using it, and you might just see a nice interest rate reduction, saving you even more money.

Just stick with contributing $700 toward your debt every month and you’ll be fine.

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25 thoughts on “A Little More Than the Minimum

  1. I’d like to know how you did your back of the envelope math to come up with 30 years to pay off her credit card debt at the minimum payment. I used Bankrate’s credit card calculator and came up with numbers about a decade sooner.

    Of course, I agree with the approach, since in this situation, her lowest debt is also her highest interest rate, so she has both simple mathematics in her favor as well as the psychological push of getting the debt paid down quickly.

  2. Unless I misunderstood, paying $117 + $57 for a total of $174 per month for 18 months (the year and a half mentioned) will fall far short of the $3,400 balance on the first card. Even without interest you could only pay off about $2,600.

  3. I didn’t check Trent’s math, but his advice is sound. And your debts are conveniently set up to be able to satisfy both the “highest interest rate first” crowd and the “smallest balance first” crowd.

    One point Trent missed is that the interest on the student loan is tax deductible, so that’s another point in favor of focusing on the other two debts first (the true effective interest rate of the student loan debt is lower than 6.75% when the tax deduction is factored in).

  4. If you have a good credit rating, you might try getting a loan with a lower interest rate than the credit card rate from LendingClub.com or Prosper.com, two peer-to-peer lending groups. You can pay off the credit card loans with the money and pay a much lower interest rate on the Lending Club loan. You can still pay more than the minimum amount on the new loan. I regularly loan money on Lending Club to borrowers who are trying consolidate credit card debt with lower interest rate as long as their credit rating is not too bad.

  5. I agree that more should be thrown at the highest-interest debt, but I (personally) HATE only paying the minimum on everything else. So I have a compromise set up. I pay a bit more than the minimum on everything ($5-$10 extra), and then I add even more to my highest interest debt. I know that I’m not technically optimizing my payments, but this is the formula that keeps me motivates to keep working away at my debt, which is more important in the long run!

  6. Good for you that you’re tackling these debts early on! I hope that in addition to the increased repayment schedule you’re putting money into an emergency fund and retirement – you shouldn’t completely ignore those in order to pay down the debts.

    Student loan interest deductions are capped at $2500 and eligibility is based on your annual gross income – check the IRS website for details.

    Suze O’s advice is usually more tailor-made than the OP and Trent suggest. She recognizes that different people have different motivators, but as I recall she advises some version of the snowball & focusing on one debt at a time. She often will advise getting the student loans paid down first, as they never go away and can’t be discharged if you get into financial problems. She definitely believes anyone carrying student loan debt should not be incurring other debt loads as well.

  7. Suze Orman does not tell people to do this exactly. She recommends paying down the highest interest debt first and paying the minimum on others.

    From her website :

    # You must pay more than the minimum payment every month, as much more as you possibly can. If you owe a credit card company $5000 at 18 percent interest and all you do is pay the minimum each month it will take you over 30 years to pay it off.
    # You must pay off the credit card with the highest interest rate first, and the rest in descending order.

    I guess the 1st item could be taken to mean you should pay more than minimum on each card. But 2nd item its clear she means pay off highest card first, therefore putting only minimum into lower interest debts.

  8. Suze Orman does not suggest making extra payments on all credit cards. She supports the snowball approach and has said this on several occasions.

  9. Yes! I agree with this as well. Suze Orman does recommend the approach that Trent has given as well. I need to follow this logic in paying off my own debt!

  10. The first thing Carolyn should do is try to negotiate a lower interest rate on those cards, or do a balance transfer to 0% or something lower. Do those two things before anything else. I would opt for the balance transfer if you have good credit.

    If she is able to get the credits card on the 0% card, she should still pay them off before the student loan. But yes, focus on one debt and attack it.

  11. This should apply to high interest debt only, not “all debt”. Volumes have been written on pre-payment mortgages, but there’s not a large financial benefit to doing so, if at all. If you have a decent rate of say 4.5%, you’re effectively paying down debt at about 4% given the mortgage interest deduction. Aside from that, perhaps those funds would be better suited for other high interest debts, an emergency fund or investing in more risky/higher return assets if you have a long time horizon.

  12. Definitely agree with the post and some of the comments. My first reaction was why not try to clear out the highest interest debt first? For every dollar you spend on student loan debt, you will be incurring the difference in higher interest on your a dollar of credit card debt. Focus all your efforts on digging yourself out of debt, and it will make your personal finance problems much easier. :)

  13. @Darwin’s Money #7:

    “High-interest” is a relative thing. 4.5% is high compared to the 0.2% interest on savings accounts that’s fairly standard these days, so if the choice is between two apparently guaranteed returns of those amounts, I’d pay down the mortgage in a heartbeat. (Assuming I am already investing for other goals, etc.)

    And there does come a point when the interest paid on the mortgage is less than the standard deduction, so you lose the “benefit” of the deduction. At that point, it pays to re-evaluate the paydown in light of comparable interest rates, goals, and other individual variables.

  14. If you ever get any offers from another cc company for a 0% apr take advantage of it. The best ones will go longer than a year at 0%. Transfer as much of the other 2 balances as you can then pay off any remaining cc debt as a priority 1. Then your goal should be to pay off the 0% card before the regular interest rate kicks in. Don’t ever be late even a few hours on a payment because your rate will skyrocket. Then tackle the student loan and don’t use your cc’s unless you can pay it entirely every month.

  15. For those 0% transfer offers – don’t add a new balance to a card you already owe a lot on. The fine print always says that payments received will go toward the higher-interest portion of your bill first. So you have less time to pay off the 0% transfer than it appears on the surface.

  16. I was going to say that Suze does not advise making larger than minimal payments on all balances. I believe she suggest starting with the card/loan with the highest interest rate. And working on from there.

  17. @Jonathan (#1 comment)
    Not all student debt is tax deductible. It depends on the type of loan, the type of degree and your income.

    Otherwise, 100% agreed.

  18. Gal, Higher income does disqualify the deduction. The type of loan just has to be an qualified student loan which would be any of the common student loans.

    But I don’t think the type of degree impacts it. What do you mean by that??

  19. Depending on how stable her job is she may want to focus on paying the student loan off first. This may sound counter-intuitive, but the credit cards can be eliminated under bankruptcy if she loses a job. The student loans must be paid come hell or high water unless she dies.

    So if this were me I would be paying the student loan as they are nastier if you try to default than any credit card.

  20. Of course Suze tells you to pay off the highest interest debt first. Dave Ramsey says that if you have one or more small debs it’s OK to pay them off first and take that extra monthly payment money and put it on the higher debts. This way you might lose a few cents over paying the higher interest debt first, but you have the immediate satisfaction of canceling some of your debt, and freeing up more money per month to concentrate on the higher interest debts.
    Darwin’s Money #7. Where today does anyone get a CD or money market paying more than a pittance? Better to prepay on the mortgage and save that interest which is after tax income. The interest on the CD is pre tax income so you are earning even less than you are paid due to taxes. Plus, at the first half of the mortgage, the savings in interest you don’t have to pay is huge. The second half of the loan, the payments are much more principal than interest, so it is not as beneficial to prepay the mortgage early unless you have no place else to go with your cash. I paid off my 20 year mortgage in 11 1/2 years. Saved thousands by prepaying. Have no mortgage payment for years. Have the freedom to sell my house and hold the mortgage (actually would do an installment sale so no foreclosure is necessary if the sale goes bad) and move to another property or part of the country if I wish. Not owing a mortgage makes you free.

  21. I also want to reiterate that Suze Orman does not tell people to pay more than your monthly payments on ALL credit cards. She recommends paying down the highest interest debt first and paying the minimum on others.

  22. Another way to look at it: student loan debt can never be discharged in bankruptcy, while credit card debt can. In case of a job loss, you could get rid of the credit card debt by bankruptcy, but the student loan debt would remain. This would have disastrous consequences in case of a job loss. Even if you pay more in interest, get rid of the student loan debt first. This will remove a great burden. Then do the snowball on the remaining debt.

  23. @erb – “In case of a job loss, you could get rid of the credit card debt by bankruptcy, but the student loan debt would remain”

    True, but in the case of a job loss, student loan payments can be deferred for up to 3 years. The credit cards cannot.

  24. Actually, if you stick it in a spreadsheet, the way to do it is to pay off the smallest debt first, then apply that amount to the next smallest amount. It doesn’t matter what the interest rate is on the largest debt; paying off the smallest debt, then adding that to the next largest debt works every time.

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