Which credit card debts should you pay off first?

I've been thinking about how to save money on debt. It's a cost cutting type of topic that will help you pay off your debt faster.

Saving money VS Paying off debt video.

As I was looking at some of the other personal finance sites, I came across a good article on fivecentnickel.com that talks about "If you’re familiar with Dave Ramsey, then you’ve no doubt heard of his ’snowball’ approach to paying down your debt. In short, Ramsey suggests that you make minimum payments on all but the debt with the lowest balance."

I disagree with Dave Ramsey's approach in that it's not the most cost effective way to pay off debt. He's suggesting that you pay off the credit cards with the lowest balance first. This psychologically is a good way to go as it gives you a sense of accomplishment. It's also a great way if you're paying the same interest rates on all of your credit cards. You can say, "I paid off a credit card in full!"

Pay off the most expensive credit cards first
Different credit cards charge different amounts of interest. Capital One's Prime +0.9 card is much cheaper than a HBC Card at 28.99% interest.

If you're paying minimum payments on your highest interest cards, you're pouring money down the drain, especially if you can afford to make higher payments.


EXAMPLE #1: Make regular payments

ASSUMPTIONS: Example #1:

1. The payments assume that you're paying 3% of the initial balance throughout the whole payment time IE. 292.50.
   
2. You're not making any extra payments at this moment.
   
3. If one credit card is paid off early, you're NOT using the freed up payment money to pay off the other card.
   

NOTE:
- I'm using Visa's credit card calculator
- These are highly simplified calculation for the purposes of illustration only.

Credit Card #1
Interest Rate: 19%
Balance Outstanding: $9,750.00
Minimum Payments: $292.50
Months to pay in full: 48
Total Interest Costs: $4,220.35

Credit Card #2
Interest Rate: 29%
Balance Outstanding: $3,500.00
Minimum Payments: $97.00
Months to pay in full: 73
Total Interest Costs: $4,119.07

TOTAL INTEREST PAID: $8,339.42

Assuming that we have an extra $200 per month to pay down these credit cards, which would be the best way to go? Should we pay down $100 on each card equally, or should use the full $200 to pay down either credit card?


EXAMPLE #2: Pay off $100 on each card equally

ASSUMPTIONS: Example #2

1. The payments assume that you're paying 3% of the initial balance throughout the whole payment time IE. 292.50.
   
2. You're going to pay $100 extra on each credit card until the first one is paid off.
   
3. You've got $200 to make extra payments with.
   
4. If one credit card is paid off early, you ARE using the freed up payment money to pay off the other card.
   

TimeLine #1 Months 1 to 24

Credit Card #1 -
Interest Rate: 19%
Balance Outstanding: $9,750.00
Minimum Payments: $392.50
Months to pay in full: 24
Total Interest Costs: $2,736.13

Credit Card #2
Interest Rate: 29%
Balance Outstanding: $3,500.00
Minimum Payments: $197.00
Months to pay in full: 24
Total Interest Costs: $1,128.09

TimeLine #2 Months 1 to 11

Credit Card #1
Interest Rate: 19%
Balance Outstanding: $5,783.26
Minimum Payments: $589.50
Months to pay in full: 11
Total Interest Costs: $551.50

Credit Card #2
Interest Rate: 29%
Balance Outstanding: $0.00
Minimum Payments: $0.00
Months to pay in full: 0
Total Interest Costs: $0

TOTAL INTEREST PAID: $4,415.72

Example #3: Pay off $200 on the more expensive credit card first

ASSUMPTIONS: EXAMPLE #3:

1. The payments assume that you're paying 3% of the initial balance throughout the whole payment time IE. 292.50.
   
2. You've got $200 to make extra payments with.
   
3. You're going to pay $200 on the most expensive credit card each month until it's paid off, and then use that $200 per month to pay off the other credit card.
   
4. If one credit card is paid off early, you ARE using the freed up payment money to pay off the other card.
   

TimeLine #1 Months 1 to 14

Credit Card #1 - 1st 15 months
Interest Rate: 19%
Balance Outstanding: $9,750.00
Minimum Payments: $292.00
Months to pay in full: 14
Total Interest Costs: $1,950.56


Credit Card #2
Interest Rate: 29%
Balance Outstanding: $3,500.00
Minimum Payments: $297.00
Months to pay in full: 14
Total Interest Costs: $668.85


TimeLine #2 Months 1 to 14.6

Credit Card #1 - 1st 15 months
Interest Rate: 19%
Balance Outstanding: $7,619.19
Minimum Payments: $ 589.50
Months to pay in full: 14.6
Total Interest Costs: $ 972.83

Credit Card #2
Interest Rate: 29%
Balance Outstanding: $0
Minimum Payments: $0
Months to pay in full: 0
Total Interest Costs: $0

TOTAL INTEREST PAID: $ 3,592.24

SUMMARY:
You SAVE THE MOST MONEY on credit card interest by paying down your most expensive credit card first and then applying the freed up payments to the other outstanding credit cards. You're also paying off your credit cards in a total of 29 months! See example #3

Interest Paid: $ 3,592.24

Example #1 is by far the most expensive as you're paying $8,339.42 in interest payments. You also take much longer to pay off your credit cards as it takes up to a full 73 months to complete the payments on both credit cards.