Editorial Policy

How to use an inheritance to pay down card debt

Erica Sandberg

August 9, 2016

Q  Hi Erica,

I received an inheritance of $10,000, but what should I do with it? I have six credit cards with card debt totaling almost $12,000. Most of that amount was not from me being irresponsible. See, I  had to pay a very large deductible on my medical insurance, and then not everything was covered. I didn’t have enough savings to cover the charges other than my 401(k), and I know I shouldn’t touch that. If I use this inheritance to pay off most of my card debt, I feel this is my chance to get my credit back in good shape. Do you think I should use the money in my checking account now to pay off most of my credit cards? And how should I do it? Should I pay some money on all of my credit card accounts or pay off all the debt owed on some of my cards? — Manny

A  Dear Manny,

You can do so much good using that inheritance to pay down your debt! It can give your credit scores a major boost, and the cost to carry over so much debt will decrease dramatically.

This is what I think you ought to do:

First, deposit $1,000 into a savings account. This can serve as a rainy day fund just in case a big expense comes up, and it’s also a feel-good measure. There is just something wonderful about having some cash in the bank. True, it won’t be enough to cover the kind of expenses that you were hit with, but you can build up more later.

Then, make a list of your credit cards by APR. The account with the highest rate needs to be paid first, then the next highest, and so on. If you don’t know what the rates are offhand, check your paper or online statements.

After you have prioritized your credit card debts on the six cards by APR, delete the balances of the highest interest rate accounts. You’ll be left with whatever credit cards remain with the lowest rates. For example, let’s say these are your credit cards, listed in the correct descending order:

Card one: 29%, balance $2,300

Card two: 24.9%, balance $500

Card three 19%, balance $5,000

Card four: 17.9%, balance $1,000

Card five: 16%, balance $1,400

Card six: 11%, balance $1,800

With the $10,000 windfall (minus $1,000 for your savings account) you would be able to wipe out cards one though four, and $200 of card five. Card six would still have the full balance on it. A grand total of $3,000 would remain.

How to erase your debt without tapping your savings account would depend on the amount you could afford to send each month. If you have $300 to spare, it would take five months and about $41 in accumulated interest to pay off card five, then seven more months to pay off card six and about $60 in accumulated interest. Send $550 and it would take three months and about $26 in fees to pay off card five and four months and about $36.50 in interest to pay off card six.

Apply this APR hierarchy system to pay down your credit cards. About a month after you pay off the bulk of your cards, you should see a huge uptick in your credit score.

The only potential downside of this plan is if the last credit card in line has a balance that is close to or at that card’s credit limit. If this is the case, your credit utilization ratio for that card is too high. However, as soon as you delete the bulk of your other card obligations, you should be able to quickly erase whatever is left over on this one card.

Once each of your six accounts shows a zero balance, choose one or two credit cards to use occasionally. To maintain high credit scores and avoid debt, charge only what you will be able to repay in full, paying close attention to the due dates so you never fall behind in payments.

Now back to that savings account. The moment you’re out of debt, aggressively start setting cash aside to build up your nest egg.

But don’t neglect an occasional pleasure. Affordable extravagances are always recommended — at least by me.

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