Debt reduction planner and promotional rates

Michael Rosen

What's the best way to handle credit cards with promotional rates that expire? I have one card with a 0% promo rate that expires in November. Quicken only knows that I have a 0% APR and tells me to just pay the minimum while I pay other balances off first.

I'm not sure if that's the best route to go.

Does that actually make sense with the goal of paying off higher balances with higher APRs?

The promo rate is not a deferred interest plan, by the way.

Thanks.

Sherlock

Generally, paying off debt with the highest APR first always makes sense as it reduces immediate cost.  When the APRs vary, it gets a bit more complicated as you also need to consider the life of the loans.  

As an example, let's suppose I had two loans of $1000 each and the ability to $200 a month.  At 0% interest, it would take 10 months to pay off both of the loans.  If the loans had an APR of 10%, it should take 11 months with $48.58 of interest on each.  Now suppose loan A offered a promotional rate of 0% for the first 5 months but then charges 20% while Loan B continues to offered the steady 10%. 

If I pay $100 a month toward each, I'll pay a total of $75.15 in interest.
If I pay off loan A first, I'll pay a total of $70.30 in interest.
If I pay off loan B for first 5 months and then loan A, I'll pay a total of $61.68 in interest.

So paying the highest APR first was better.

If instead of 20%, say loan A jumped to 25%:

If I pay $100 a month toward each, I'll pay a total of $82.30 in interest.
If I pay off loan A first, I'll pay a total of $70.30 in interest.
If I pay off loan B for first 5 months and the loan A, I'll pay a total of $70.98 in interest.

So, paying off the lowest APR first is now better.

So what's happening?   The significant change is the size of the bump in loan A's interest rate.  Note: The longer it's necessary to carry the loan at a higher rate, the more interest will accumulate as compared to carrying the loan at a lower rate.

The good news is that since most credit card's normal APRs are comparable, paying the highest APR loan off first is best most of the time.

Sherlock

Generally, paying off debt with the highest APR first always makes sense as it reduces immediate cost.  When the APRs vary, it gets a bit more complicated as you also need to consider the life of the loans.  

As an example, let's suppose I had two loans of $1000 each and the ability to $200 a month.  At 0% interest, it would take 10 months to pay off both of the loans.  If the loans had an APR of 10%, it should take 11 months with $48.58 of interest on each.  Now suppose loan A offered a promotional rate of 0% for the first 5 months but then charges 20% while Loan B continues to offered the steady 10%. 

If I pay $100 a month toward each, I'll pay a total of $75.15 in interest.
If I pay off loan A first, I'll pay a total of $70.30 in interest.
If I pay off loan B for first 5 months and then loan A, I'll pay a total of $61.68 in interest.

So paying the highest APR first was better.

If instead of 20%, say loan A jumped to 25%:

If I pay $100 a month toward each, I'll pay a total of $82.30 in interest.
If I pay off loan A first, I'll pay a total of $70.30 in interest.
If I pay off loan B for first 5 months and the loan A, I'll pay a total of $70.98 in interest.

So, paying off the lowest APR first is now better.

So what's happening?   The significant change is the size of the bump in loan A's interest rate.  Note: The longer it's necessary to carry the loan at a higher rate, the more interest will accumulate as compared to carrying the loan at a lower rate.

The good news is that since most credit card's normal APRs are comparable, paying the highest APR loan off first is best most of the time.

Michael Rosen

Thanks. That makes sense.