APR%s and Debt

Jauerback · #1 04-26-2007, 10:08 PM

A friend of mine has some credit card debt. He wouldn't give specifics, and I didn't ask, but he said it was nothing major, that he could easily pay off in a year or two. However, he was trying to be smart about it. So, he asked me a question, and quite frankly, I didn't know the answer.

Hypothetically, in the scenario that he gave me, if he has two credit cards and one has a balance of a $10,000 with an APR of like 15%. His other card has a balance of $1000, but an APR of 25%. My initial thought was for him to pay the higher APR off first, and make only minimum payments to the lower one. But, then he pointed out how different the finance charges were between the two. In this case, would it make more sense for him to pay off the card that has the higher finance charge, but the lower APR?

Explain this to me like I'm a four year old, please.

Thanks in advance for your help.

Shoe · #2 04-26-2007, 10:15 PM

The finance charge is just the interest he is paying. The reason his card with the lower interest rate has a higher finance charge is because he has 10x the balance on that card. He should pay off his $1,000 card first, then start paying off his other card.

Jauerback · #3 04-26-2007, 10:19 PM

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The finance charge is just the interest he is paying. The reason his card with the lower interest rate has a higher finance charge is because he has 10x the balance on that card.

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Okay, I understand that.

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He should pay off his $1,000 card first, then start paying off his other card.

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That's what I thought. Then he argued that the higher finance charges (because of the larger debt), would make him lose more money in the long run. I didn't know enough to argue.

john kane · #4 04-27-2007, 12:23 AM

yeah, say to him he has 11K in debt. 10K causes him more pain than the other 1K. if he could remove 1Ks worth then he should choose 1K of the 10K to remove more pain.

IRuleYouHard · #5 04-27-2007, 12:28 AM

[ QUOTE ]
yeah, say to him he has 11K in debt. 10K causes him more pain than the other 1K. if he could remove 1Ks worth then he should choose 1K of the 10K to remove more pain.

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I know the right answer but man this confused me! [img]/images/graemlins/blush.gif[/img]

Shoe · #6 04-27-2007, 12:39 AM

To put it another way:

The 10k at 15% has a "finance charge" of approximately 125 per month ($12.50/month per $1,000 in debt).

The 1k at 25% has a "finance charge" of approximately $20.83 per month. ($20.83/month per $1,000 in debt)

So even though the 10k costs him more in interest he is not looking at the big picture. He is really 11k in debt, and the 1k at 25% is costing him an extra $8 a month if he does not pay it off first. Not a huge mistake, but still, a mistake.

nineinchal · #7 04-27-2007, 10:48 AM

Your friend?

Perplexity · #8 04-27-2007, 11:14 AM

Can "he" really be this dumb?

Pay off the higher interest rate debt first. Sheesh.

ScottieK · #9 04-27-2007, 11:21 AM

Can he get a loan with a lower interest rate (like a Home Equity Loan) to pay off his credit cards? Even if he got a rate reduction to 10%, that would help. 7% or 8% would be huge. Even transferring his $1,000 at 25% APR balance to his 15% credit card would help a little. Maybe he can call the credit card companies to negotiate a lower rate?

If not, then I think he should pay off the higher APR debt first, as explained above. That card has a higher finance charge because of the larger amount on it, not because of the APR. Ask him if he could put all his debt on one card, which one would he pick...the one with a 15% APR or the 25% APR? The one he chooses should be the one he pays off last.

But also, to be smart, he shouldn't totally ignore his $10K card. Late or missed payments will result in late charges, negative marks on his credit history, and maybe a severe reduction in his credit limit. Guess he should make minimum payments on that credit card until he pays off his $1K card, then focus on paying down the $10K card.

ScottieK

ClubChamp04 · #10 04-27-2007, 07:34 PM

I would get another CC if he has any kind of credit left. Transfer the 1K and as much as possible of the 10K @15% to a CC with a specail tranfer balance rate of 3.99% or less(any offer less than 15% would be beneficial though). That would save him upwards of $100/month if done at 3.99%.