So, you’ve come into a little extra cash. Maybe you got a bonus at work, or your pet walking business got busy over the summer. Now, you want to pay off some debt — a credit card or your car loan.
How do you decide which one?
You might say, “my car loan – that’s the biggest balance.” But does that make the most sense from a numbers standpoint?
Do some simple math and pay down the one that’s costing you the most. Note: The math gets more complicated if you’re trying to be precise, but we’re not doing that — a back-of-the-napkin estimate can help you make the right decision.
Here’s how:
1. Make a simple chart of your debts:
| 1. You owe | 2. Balance | 3. Annual interest rate (APR) | 4. Monthly interest rate (Divide APR by 12) | 5. Monthly interest charge |
| Retail Visa | $ 3,000 | 23% (aka 0.23) | 1.92% (or 0.0192) | |
| Bank Visa | $ 13,000 | 19% (0.19) | 1.58% (0.0158) | |
| Car loan | $ 20,000 | 4% (0.04) | .33% (0.0033) |
2. Multiply each balance (column 2) by the monthly interest rate (column 4) to fill out column 5. That’s roughly how much interest will be added to your balance next month. For example, on the Prime Visa: $3,000 x 0.0192 = $57.60.
You’ll end up with a chart like this:
| You owe | Balance | Annual interest rate (APR) | Monthly interest rate (Divide APR by 12) | Monthly interest |
| Retail Visa | $3,000 | 23% (aka 0.23) | 1.92% (or 0.0192) | $57.60 |
| Bank Visa | 13,000 | 19% (0.19) | 1.58% (0.0158) | $205.40 |
| Car loan | 20,000 | 4% (0.04) | .33% (0.0033) | $66.00 |
What do you notice?
You’re racking up roughly $57 per month in interest charges on the Retail Visa, vs $205 on the Bank card and $66 on the car loan.
While you may think you should pay down the car loan first because it’s your biggest balance, the Bank Visa is costing you way more. And, while you may think it makes sense to pay the card with the highest interest rate first, it depends on how big a balance you have on each card. The higher the balance, the more interest is costing you each month.
To be clear, there are different ways to pay down debt and emotions play a big role. If you feel better knowing you’ve completely paid off a credit card, regardless of the math, go for it. That’s a win. If you like the idea of paying off the most expensive debt first, try this method.
If you want to learn more about credit card interest and would rather not do the math yourself, use this Nerdwallet calculator.