Question

3. Use Sydney's Minimum Payment Summary to answer the statements that follow.

Sydney's Minimum Payment Summary
Card Card Card Total
Month A(18% B[20% (24% Monthly
APR) APR) APR) Payment
1 $32.19 $43.43 $50.28 $125.90
2 $30.83 $41.79 $48.98 $121.60
3
$38.67 $46.14 $113.46
4 $26.31 $36.12 $43.98 $106.41
$28.65
Sydney has been paying the minimum balance on her three credit cards each month. She has outlined the minimum payments for the next four months. She decides to snowball her debt after Month 1 according to the interest rate
instead of paying the minimum payment.
Part 1 (2 points): Explain, using complete sentences, how the total monthly payment will change for each month
Part 2 (2 points): Explain, using complete sentences, how the payments for each credit card will change for each month. (4 points)

Answer 1

Step-by-step explanation:

Part 1

The total monthly payment will remain level at the amount currently scheduled for Month 1. The revised totals are shown at the bottom of the attachment.

When Card C is fully paid, the same total payment will continue to be used until all card debts are paid.

__

Part 2

The excess over the sum of minimum payments will be applied to Card C (24% rate). The minimum payment will continue to be made for the other credit cards. The revised Card C payments are shown at the bottom of the attachment.

When Card C is fully paid, the excess over the sum of minimum payments will be applied to Card B (20% rate).

_____

Comment on the question

You can't think too much about the given numbers. The minimum payment amounts given here decrease way faster than you would expect. For example, the $1.36 decrease in the minimum payment for Card A from Month 1 to Month 2 corresponds to a balance decrease of more than $90 when the interest rate is 1.5% per month. That is not possible if the payment is only $32.19.

Apparently, the question is not about the actual numbers. Rather, it is about the strategy of debt reduction. Some (bogus) numbers are given here just so you have something to think about.

The approach described in the problem statement has been given the name "debt avalanche" to distinguish the approach from Dave Ramsey's "debt snowball." The "debt snowball" approach pays off the minimum balance first, not the highest interest rate. It also includes some extra cash above the sum of minimum balances. ($100 is suggested; more is better.) The psychological effect of the quick win is considered to be more important than the extra cost of carrying the higher-rate debt for a longer period.