plonkee money an english-er's thoughts on personal finance

April 18, 2008

supercharging the debt snowball

Filed under: credit and debt — Tags: , , — plonkee @ 12:00 pm

supercharged

Yesterday, when I explained about Dave Ramsey’s debt snowball, I said that the biggest drawback is that you end up paying more by paying off your debts in order from smallest to largest, than you would if you paid them off in order of highest interest to lowest interest.

Now, unlike Dave Ramsey, who is hot on psychology, arguably the biggest finance guru in the UK, Martin Lewis – the Money Saving Expert, is all about the maths. If he made over your finances, he’d never have you paying off your debts smallest to largest, instead he’s pick the more rational choice to pay them off highest to lowest interest rates. Funnily enough, I’m pretty sure that Martin has never had a debt problem.

What if you could make it so that the smallest debt also had the highest interest, and the largest debt also had the lowest interest?

Then it hit me, that’s the outcome you’re aiming for when you use Money Saving Expert’s credit card shuffle. You can have all the psychological advantages of the Dave Ramsey method, whilst still getting the financial rewards of paying off higher interest debts before lower interest ones. And it doesn’t mean that you take on any more credit.

The time to do this is once, at the beginning when you’re setting up your debt snowball. (If you’ve already set it up, you might want to revisit it to see if you can save money with this technique.) You’ll need a list of all your debts together with total amount of each debt, the interest rate and the credit limit.

the credit card shuffle

Mostly, this works better with credit cards and overdrafts than it does with other loans – you need to check the terms of your loan to see if it will be worthwhile.

step 1: ask them to lower their interest rates

This is easy. All you need to do is call up each credit card company and ask them to lower the rate. They might just do so. If they do, make a note of the new rate.

step 2: find out about special deals

Whilst you’re on the phone to the credit card company trying to get your interest rate lowered, ask them if they have any special balance transfer offers for new customers – if there are, write those down as well.

step 3: the shuffle

This is the more complicated step. The idea is that you move your debt from the higher interest cards (or overdraft) to the lower interest cards.

Suppose you have 3 credit cards and an overdraft:

  1. Visa £1k balance, £3k limit, @ 6.9%
  2. Amex £2k balance, £4k limit @ 12.5%
  3. Overdraft £2.5k, £2.5k limit @ 13%
  4. Mastercard £4k balance, £5k limit @ 17.9%, (lifetime balance transfer deal @ 9%)

Here, we want to get as much debt as possible onto the Visa, then the new balance transfer from Mastercard, then the Amex, then the overdraft then finally, the old rate on Mastercard.

Firstly lets start by moving the most expensive debt onto the least expensive card.

  • transfer £2k from the Mastercard to the Visa

The Visa is now full up, but we still have £2k on the Mastercard. We can’t put this on the new offer, but we can put this on the Amex.

  • transfer £2k from the Mastercard to the Amex

At this point we have no debt on the Mastercard, and the Amex is full. The final steps in the shuffle are to use the special balance transfer offer transfer.

  • transfer £2.5k from the overdraft to the Mastercard (new balance transfer rate)
  • transfer £2.5k from the Amex to the Mastercard (new balance transfer rate)

After the shuffle we are left with:

  1. Visa £3k balance, £3k limit, @ 6.9%
  2. Mastercard £5k balance, £5k limit @ 9%
  3. Amex £1.5k balance, £4k limit @ 12.5%
  4. Overdraft £0k

The smallest balance has the highest interest rate, and the larger balances have lower interest rates. Everyone’s a winner (except the credit card companies).

Now, if you think that it sounds too complicated, on the Money Saving Expert site you can download a credit card shuffle worksheet to help you. Also, you only have to do this once, when you set up the snowball. Finally, even doing a little bit of a shuffle will save you money in the long run, and get you out of debt more quickly.

Hot or Not? Let me know what you think in the comments.

Image by The359.

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