Appling Payments to Debt

Having problems deciding on which debt to payoff or to apply extra money. Will walk thru the process on making this decision step by step.

Article Link: 
https://www.nerdwallet.com/article/credit-cards/how-credit-card-payments-applied  By Claire Tsosie & Sara Rathner

Transcript

Charles McDonald: 0:02

Hello, I'm your host, Mr. Chuck, a retired accountant turn truck driver, I reduce my debt in a relatively short period of time, debt reduction to achieve financial freedom takes commitment, confidence determination. Applying payments to debt, having problems deciding on which debt to pay off or to apply extra money, I will walk through the process on making this this decision step by step. But before I talk about applying money to your debt, I like to talk about on how credit card payments applied to your balance. And this is what the credit card companies are doing. When you make a payment on your credit card. This is the process they go through to decide where to apply the money. And the reason that's important is because your credit card debt is broken down into three different categories. A purchase balance for things you bought with the card, a balance transfer, for debts moved from the card from other accounts, and a cash advance balance for money withdrawn from a ATMs with the card. So your credit card basically have three distinct different areas that they keep track of. And each one of them, they are charging different rate of interest, your cash advance balance is gonna be the highest rate of interest, the balance transfer might be a 0% interest for a while. And because you might have had an offer, and you transfer it over and they're charging interest on that, and then you continue to use the same card to make new purchases by land has a third rate of interest. So that's why he's broken down in these three things purchase balance, balance transfer, cash advance balance, I've talked about in the past that you pay off your car, and you don't close it. And then down the road, maybe three months, six months later, that card makes you an offer, we can transfer a balance onto that card and have 1218 months of zero interest. And we'll find you pay a transfer fee of 3% or 5%, or whatever it is, and you can reduce the amount of entry you're paying. But if you had notice, I'm only telling you to do that to transfer amounts onto a card that has a zero balance. That way you can avoid the purchase balance and a cash advance bounce. In fact, you should never ever get a cash advance on a credit card. That's like 30% rate of interest. That's loan shark. There's cheaper ways to borrow money than doing the cash events on your credit card. And why you get into cash events you getting into buy something what is used a credit card to buy and you get a lower rate of interest. Okay, so how are they doing this when you because of the rules specified in the credit card act, your issue or the card issuer divides your car payments into two parts. Now there's three parts within three different separate balances on your any one card. But when you make a payment, there's two ways they apply it. The minimum payment is the portion of your balance, you're contractually obligated to pay each month, this is the minimum balance, the issuer can apply the minimum to whatever balance it wants. Often, this means the minimum goes towards the lowest interest balance rather than your most expensive one. So what are they saying they're your minimum payment, then that's what I'm telling you to make the minimum payment. So when you make the minimum payment, if you have a car where you have purchases on it, you have a transfer balance on it. And you have cash amounts, the minimum payment is gonna be applied to whichever is the lowest rate of interest. And they do that because they can make the most money by doing that. So if you have a balance transfer or zero interest, they're gonna apply it to that and it'll be paid off sooner. But your interests on use other two balances your purchases and or your cash romance is going to continue to grow because nothing is getting apply to it, then the excess payment. The excess payment is everything you pay above the minimum, the CARD Act requires issuers to apply this part of your payment to the highest interest balance first, after that the remainder generally must be applied to the our balances, and descending order based on the application annual percentage rate, according to the law. So if your minimum payment is 25 box dollars a month, and you've been making $50 a month, you know,$25 Extra, the minimum is going to be applied one to whatever interest you owed first, and then to to whichever has the lowest interest balance was the lowest rate of interest that other $25 by law is going to be applied to whichever balance has the highest rate of interest, which is good, but $25 a month is not going to make much progress. And that's why I tell you to have an emergency fund. And do it that way. When you're offered that balance transfer. With a zero rate of interest, there's two different options that credit cards have. Most of the time having an issue, apply your excess payments to the highest interest balance is the most cost effective option. But the CREDIT CARD Act makes an exception for deferred interest off offers, often found on store cars and medical cars. That's because leaving those no interest, if paid in full balances can last for last can have expensive consequences. Deferred interest is the difference from the 0% APR offers, you see on the bank, credit cards, and here's how, okay, there's two things they do. The first one is a zero APR card, you're not charged any interest during the 0% period, the interest is waived entirely. Once up is up, you can be charged interest only on the outstanding balance going forward. That's a good thing. With deferred interest offer. By contrast, if you have not paid off the purchase in full at the end of the interest free period, you'll be charged recto active interest going back to the original purchase, do not do it balance transfer on to a deferred interest offer card, unless you know you can pay it off by the due date. Because if you don't pay it off, if you transferred 5000 And you got it down to $500. And it goes past that date, they go back to day one figure interest on the 5000 For how long it was apply a payment, unpaid balance unpaid balance. So you're gonna pay pretty much close to the same interest that you would have paid left that were watts. So it's important, I always assume that if I don't look, I assume the card has a deferred interest off offer, which means I gotta pay it off before that time period is up for the 0% rate. And I've never had any problems making those assumptions. So assume the worst plan for the worst and you're gonna come out with the best option. Now they say it's mostly department store credit cards, but it could be regular credit cards to be were on that. And just know, your credit card is made up of three separate balances, they all have their interest rates are different, depending on what's going on, and why they apply your money when you make a minimum payment is to the lowest interest balance first course first thing I'm gonna do is pay off all the interest you owe and for the month, and then whatever is left after that it's gonna go to the lowest interest. So be$25. It could be five bucks be applied to your principal, transfer any unpaid balances to a card on these zero interest rate offers, unless that card has a zero bounce to start with. That way you don't get caught up. And the different ways they apply the money. It's straightforward clean, you know it's going to be applied to that$1 amount and it's not going to pay any interest. So that is what we're trying to do here. So you've ad two point do you have a bunch of debt Maybe you have four or five student loans, you have three or four credit cards, you have a couple of car loans, you have a line of credit on your home, you have a first mortgage, and you're living paycheck to paycheck and you're, you're struggling and you don't know which one the pay. But you got things under control, you started doing your tracking, you got a budget, you want through your monthly spending, you cleaned up and got rid of things that you no longer need one or use, and you quit paying for it. So you're getting a little bit extra money, you got your emergency fund set up, you have a build up to the $4,000, your$1,000 minimum plus the 3000. Extra. And now you're to the point, what's one, what do I pay off, I got three grants, I could put 500, here, here, here, here, here, or I can put 1500 on this one and 1500 on that one, or I can pay 1000 from three different ones, whatever, you don't do that. You pick one of your debt ply, the total 3000. So now it comes down to which one? Do you apply that 3000 to that extra amount, we're going to keep it together. And we're going to apply it all in one place to get the maximum benefit from it. But how do you know which one you want to pay off? I've talked about in the past, there's two ways to application two, combined convention conventional methods. One is the Avalanche Method, which you put all your debt in order by interest rate. So you pay it towards the highest interest, whichever you're paying the most interest on the highest interest rate, or the snowball method, which you look at what's the unpaid balance, apply it to the one that you owe, the less money on, it doesn't matter what you do, which it either or, generally speaking, if you pay down the one with the highest rate of interest first, no matter what the unpaid balance, you're gonna pay over the long term, less interest, it's gonna seem like you're not making any progress. Because it may be the credit card with a $20,000 balance, and you plunk 3000 on it. Now you have a $17,200 balance, and the next time you get any didn't make any new charges, because you got $200 in interest. And you feel I'm not making any progress is gonna take forever, I'm not going to make any for a moment, if that's the way you think and feel. And you need to see some advancement. And you need to look at something and saying, I'm making progress here, look at that I've already paid off something, I almost got this one paid off. And next month making the minimum payment is going to be paid off or close to it. And maybe I'll pay that extra five bucks, so it gets paid off next month. And I'm doing good. If you're that type of person, then pick the one with the lowest balance and apply it and get some make an achievement. And you can check off I paid off one credit card. Maybe not this time, but maybe next month, he still made an achievement in your making in advance. After that first time, I highly recommend you go back to the right highest rate of interest and start applying all your excess money, the money and over the $1,000 and your emergency fund to whatever debt has the highest rate of interest. Again, you do not close that credit card. Hopefully it was a credit card that you paid off. It could have been a student loan that you was getting close. Maybe you have to student loans are getting low and you'll be able to pay both of them off. Whatever the case, if you pay off something that's not a credit card, then that counts gonna get closed out. But if you pay off and it's a credit card, do not cancel the credit card. Now if your credit is so bad, that creditor may close it for you. There's nothing you can do about it. But our goal here is to keep all the credit cards that we have Pam down to zero don't care hands on, use them occasionally to keep them active. So that you can get that balance transfer zero rate entrust, sooner than later, you want to make it work for you, and quit this process of your credit card working against you. So but if that is not working for you, you just need to get it all out in front of you sorted out, I would put all my credit cards in one pile my Sloane's in a pile, my car payments and a pile my home loans and a pile, separate them by category. Generally speaking, your credit cards, there's gonna be a high rate of interest, maybe some of your student loans might be a higher rate of interest, maybe some of them are low rate of interest. So within each pile, you want to put the highest rate of interest on the top and the lowest rate interest on the bottom. Okay, and you got and same thing with your car payment car loan, same thing with your homeowners loan, and then this look through there. Which one of those I'm gonna do it the first time which one of these has gotten me the most advant advantage to me that I can make a big progress towards. And maybe it might have a high rate of interest, this student loan here, I owe $3,500 on it. And it's got a 9% rate of interest. And as credit card here, I owe 20,000 on it. And it has a 20% rate of interest. What do I do? Well, if you want to make some progress, pay off that one student loan, if you want to reduce the amount of interest you're paying on a regular basis, apply it to that 12 $20,000 balance on that high rate of interest, credit card interest, if you look through there, and maybe you have a credit card that's a balances, maybe have two or three credit cards where the total amount of the balance is $3,000 or less, I would take those out first and pay them all off. And why because that's three minimum payments, you're gonna quitting, that's three minimum payments you're gonna be putting in to your emergency fund, and that's gonna build it much faster. So it all depends on what you're looking at. It all depends on your personality, if you need to feel like you made some achievements. That's one way to go. If you just want to pay off the highest interest first, that's another way. But the very first time you kind of got a blend them together. And maybe every time you got to look at what you owe, and how much you what's the unpaid balance, and, and what on all on everything I owe, and is anything getting close to being paid off, that if I apply $1,500 to it, it's gonna have a zero balance. That's the one you want to focus on right now. Even if it's the fourth or fifth time you've done this, because you're still making the minimum payment as you're building up your emergency fund. And that minimum payment is bringing down your balances. And you might get one or balance down low enough where that extra amount of money Oh, the amount above your 1000 can be applied to it to get it paid off. What's our goal here, our goal here is to get out of debt to pay off our debt. So if we can pay it one off today, instead of next time, we might be better off. And if you do that, over time, maybe three or four times you applied to throw $3,000 Extra and you you're getting things whittled down now you gotten rid of the ones that had the smaller balances, you got rid of them, maybe a couple of smaller bounces have high rates of interest to them also, which is good because now you got rid of them. So now the total amount of your debt is shrinking. And the total number that you owe is shrinking. So it's been more controllable. You getting it under control. The same thing goes your credit cards, your your student loans, your auto loans. Whatever the case, even though you pay off your automobile loan does not mean you had to go out and buy a new car means you no longer have a car payment, but you still got the maintenance on the car, and you still have the car, and the Now it's worth more than what you owe on it. So it becomes an asset instead of a liability. An asset is something that you can sell and get cash for a liability is something you owe. If you sell it and still owe a balance on it, you can't sell it because you have to have the money to pay it off. In order to transfer the title. That's a liability. You keep doing this time, a time over time over time, and it might shift around, maybe you applied to 3000 to one this time. And then the next time you're looking at it as Oh, lemon, this one here, if I apply 3000, it's gonna be almost paid off. So let's do that one, even though it's a little bit less interest. But let's do that one, because then maybe in two months, at the minimum payment is going to be paid off. So it's a never ending process, you're always looking, reviewing and deciding on where your money should go. Remember, on your credit cards, he wants to try never to do a cash advance on them. To start with, you only want to use them to make purchases. And if you have a credit card was a zero bounce. You don't owe anything on it, you hardly ever use it. And you get an offer to transfer a balance, then you can use that one to transfer a balance. And maybe you have zero rate of interest for a while. But make sure you pay it off in that time they allow you was 12 months or 18 months. So don't figure out how much you can pay. And pay that every month and get it paid off, it will save you some money because you'll be paying less interest on another card. It all works together, he have to get it under control, you got to do your tracking, you got to do your budget, you got to try to look for ways to reduce your spending. So you can put more in your emergency fund. And you can build it faster. So you can apply money to a credit card sooner at all is this one big cycle that keeps going over and over and over. I'll be back in one moment with my final thoughts. If you're interested, and the software that I use personally, to reduce my debt, I have a link in my show notes, shop financial.com, copy and paste it. And it will take you to the website. If you are looking for any spreadsheets or other information that I talk about from time to time, I have links in my show notes. And I always have links to the articles I refer to and my show notes, plus other things like the happy draft.org, which is a another organization that helps you with your debt. So feel free to go on my show notes and link and check out whatever I'm putting out there, I appreciate it very much. If you would like to make a contribution to help keep this alive, then I would gladly accept that send my show notes. Thank you very much earlier in this episode, I said maybe we can use the way credit card applies payment, and reverse to decide how we're going to apply our payments. So in reverse would be we apply it to the highest rate of interest, the minimum payment. But you don't have a choice on that because they're going to do whatever. So we're only talking about that extra amount of money. And that's why I say you make your minimum payment on that debt first for the month. And then you wait a day or two, because you let them apply the money. And then you put your excess amount of money, the amount over the 1000 from your emergency fund that you can apply this particular month, then after the minimum payments have been made. That's when you apply the extra amount, because we want to pick something that has the highest rate of bounce or highest rate of interest. So knowing the makeup of the credit card debt for that particular credit card, you can apply it did you transfer a balance over to that the has zero rate of interest? Have Do you have a purchase balance on there with high rate of interest as a cash advance balance on there? Try to apply it to the highest rate of interest. Now by law, they're required to do that. So you just need to pick the credit card and apply the money and the bylaw. The credit card company is required to apply it to the balance with the highest interest rate, then if that's paid off the next balance with the highest interest rate. So that was gonna happen automatically. So, but we were working in reverse with a credit card, the credit card company wants you to pay off the lowest interest balance first, and leave the highest interest balance as high as possible for the longest possible time. So they can collect the most money. Our goal is to ply it to the highest interest balance, so we pay the least amount of money, if you can understand that concept, do you know what's going on, and you'll know what decisions to make, other than being reasonable. If I apply$3,000 to this debt, when we'll have a zero balance. Now, if if I owe 5000 on it, and I have two or three of these, this one I owe 3000 is 105 1000s. When I owe 6000, well, you pay off the 3,001st thing you pay off, you know, because the goal here is to get out of debt. And the less the amount of minimum payments we have, the more that can go into our emergency fund and the faster it will build. So over time as this debt is paid down, and you have less and less debt that has gone to speed up your process, it may take you six months, nine months to get that first $3,000 to apply. And then it might seven, eight months the second time and then seven months, the third time, but a year or year and a half down the road that may be taking your three or four months to build that same dollar amount. And it's gonna be speeding up and you're gonna make some progress, and you'll be glad you did so