An individual has three credit cards with debt and different interest rates. Car

Question

An individual has three credit cards with debt and different interest rates. Card 1 has $500 of debt and 1.5% monthly interest rate, Card 2 has $750 of debt and 2.0% monthly interest rate, and Card 3 has $1000 of debt and 1.0% monthly interest rate.

If the individual sets aside $500 per month to pay off the debt, how should the $500 be distributed to three cards to minimize the amount of interest? (e.g Card 1 = $150/month, Card 2 = $100/month, Card 3= $250/month. The sum must add up to $500/month.)

Explanation / Answer

Since the card 2 interest rate is maximum, we need to pay off this debt first. So since card 2 has $750 of debt, he will pay entire $500 (which he has kept aside each month) in card 2 in the first month

So in month 1, we pay off card 1 = 0; card 2 = $500; card 3= $0

Now outstanding debt will be card 1 = $500; card 2 $250 and card 3 $1000

Now in second month, $250 of card 2 debt will be repaid and $250 of card 1 debt will be paid (as card 1 interest rate is more than card 3 interst rate)

So in month 2, we pay off card 1 = $250; card 2= $250; card 3 = $0

Now outstading debt will be card 1 = $250; card 2 = $0; cars 3 = $1000

Now in month 3, we pay off card 1 = $250, card 2 = $0, card 3 = $250

Outstainding debt after month 3 payments will be card 1 = 0; card 2 = 0; card 3 = $750

Now pay $500 in card 3 in month 4 and remaining $250 in card in month 5.

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