Jean Chatzky answers your financial questions about the best way to repay debt

In honor of Financial Literacy Month, Jean Chatzky, author and financial editor for the Today Show, is personally responding to five consumer questions. Today, Jean answers Terrence’s question about the best way to repay debt.

Question: Is it financially savvy to pay off credit cards with the highest rates first or lowest balances first? I’ve heard pro’s for each. Lowest balances first being that you free up minimum payments which can be added to payments on the next ascending balance card. Thank you in advance. -Terrence

Answer: You want to pay them off highest interest rates first. And in this example you’ll see why:

John has 5 credit cards. He owes:

$5,000 at 29.9 percent with no annual fee
$1,500 at 24.9 percent with a $49 annual fee
$700 at 27.9 percent with no annual fee
$600 at 7.9 percent with a $49 annual fee and
$400 at 11.9 percent with no annual fee
Total debt: $8,200

Option 1: Pay as much as you can afford on the card with the highest interest rate, while making just the minimums on the others. Let’s say John can afford to pay $350 a month, total. Assuming his minimum monthly payments are calculated as 2.5% of the card’s balance, at the onset, $206 of that will go just toward meeting those. He can then start by putting the remaining $144 toward the first card, with the 29.9 percent interest rate. His end result:

Total interest paid: $3,266.46

Option 2: Pay off the cards with the lowest balances first while making the minimums on the others. Assuming John still has $350 to throw at his credit card debt each month, and the minimums on the cards are the same, he’s still left with $144 extra to go toward the card with the lowest balance, Card #5 in the above calculation. Here’s how it shakes out:

Total interest paid: $3,933.12 – a difference of about $666, or a big boost to your savings account.