No one likes carrying high-interest credit card debt, but there are circumstances when paying it off right away can be a big mistake. A common question I hear from my financial planning clients is, “Should I pay off all my credit cards?” They have some kind of lump sum in hand—whether it’s a bonus, an inheritance or a gift—and the urge to throw everything they can at their debt is strong!
When we simply do the math, it seems perfectly logical to jump right in and pay off any high-interest debt and be done with it. According to CreditCards.com, the average credit card debt per U.S. adult (excluding zero-balance cards and store cards) is $4,878, and the average APR on credit cards with balances is 12.76%. The interest costs for one year would be over $600 (if you didn’t add to the debt). With interest rates for a one-year CD hovering around 0.75%, you’d only earn about $36 on that $4,878 if you kept it in your savings. If this were a math assignment, it would make perfect sense to pay off the debt in full with a windfall. In theory, wiping out credit card debt solves the problem, but in practice, it might not.
The problem of carrying high-interest credit card debt goes deeper than simple math. Unless the cause of the debt is diagnosed and treated, the debt can easily come right back. What is worse than paying $600 for one year in interest on a credit card? Paying it off and having it all come back again! You’d be worse off than before, with your windfall gone while $600 a year in interest remains.
What’s the answer? People often miss two steps when paying down debt. Here are all three steps to helping you get out—and stay out—of credit card debt: