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With more rate hikes coming, here’s the best way to pay off your credit card debt

A shopper uses a credit card to pay for her items at a Wal-Mart Supercenter in Denver, Colorado.
Matthew Staver | Bloomberg | Getty Images
A shopper uses a credit card to pay for her items at a Wal-Mart Supercenter in Denver, Colorado.

The cost of borrowing money is going up, so it's time to get serious about paying down those unpaid credit card balances.

The average household with credit card debt has a combined balance totaling $16,748, according to the 2016 American Household Credit Card Debt Study by NerdWallet, up nearly a thousand dollars from 2015.

Last week's decision by the Federal Reserve's to boost short-term interest rates will be passed along to variable rate accounts — and that's most credit cards — within the next one or two billing cycles. And if the Fed boosts rates two more times before the end of the year, as is expected, carrying a balance will cost even more.

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"Now is the time for cardholders to put debt repayment into high gear, finding extra room in their budgets to pay off those balances as quickly as possible," said Bruce McClary, vice president of communications at the National Foundation for Credit Counseling. "If you carry a balance from month to month, you're going to pay more and more for what you purchased and that really adds up over time. And if you're only making the minimum payments, you're just spinning your wheels and it could take years, sometimes a decade or more, to pay off a large balance this way."

For most American households, credit card debt is their highest-interest debt. The average credit card interest rate is currently 16 percent, according to Bankrate.com.

"If you want to go from being hurt by rising interest rates to benefiting from them, pay off this debt."

"That means that by paying off those credit card balances, the average cardholder is making a risk-free return of 16 percent," said Greg McBride, chief financial analyst at Bankrate. "If you want to go from somebody who's being hurt by rising interest rates to somebody who can benefit from them, pay off this debt and then funnel that money into savings instead of pouring it into interest payments each month."

You need a plan

The average American family has four credit cards with different amounts owed on each one. Most just try to deal with all of the balances at the same time. Financial advisers often suggest one of two common payback strategies:

  • Debt Snowball: You start with the smallest balance and work your way to the largest one.
  • Debt Avalanche: You focus on the card with the highest interest rate, pay that off first and then move on to the next.

The question is: Does it matter which approach you take?

It actually does, according to a recent study reported in the Harvard Business Review. How you pay off your card balances can determine whether you'll be successful at reaching your goal. Based on these results, it's best to concentrate on one account at a time — the snowball approach — starting with the smallest balance.

"People who chose to pay off their credit card balances one at a time were far more successful in paying those off and paid off more in subsequent repayments than those who paid off cards simultaneously," said study co-author Remi Trudel, assistant professor of marketing at Boston University.

The study involved an analysis of three years of anonymous credit card data for 6,000 people who were clients of HelloWallet, a company that provides personalized financial wellness guidance to employees. It also included three controlled experiments with participants who were assigned different repayment strategies.

"The most surprising finding was the actual size of the effect of paying off the smallest balance first," Trudel told NBC News. "I figured this would be more motivating, but I really didn't think it would lead to such a large increase in repayment. In one of our experiments, we had people closing all of their accounts and getting out of debt 15 percent quicker than others."

The authors concluded that it's not the size of the payment or how little is left on a card after a payment that has the biggest impact on the perception of progress; it's what portion of the balance they succeed in paying off.

"The worst approach was to apply a very large payment to an account with a very large balance and leave the small balances untouched. That was very demotivating to people," said study co-author Simon Blanchard, assistant professor of marketing at Georgetown University. "It turns out that focusing on larger payments of small accounts can be really motivating and so we work on increasing our income, reducing our spending and just doing smart things in general financially."

"It's like running a marathon," said Trudel. "If you focus on running the 26 miles, it's really difficult to do so motivationally. But if you break it down into two-mile increments, it's far more motivating and you'll have far more success."

What about consolidating your credit card debt?

People with multiple credit cards are often encouraged to consolidate their debt into one loan to make it easier to manage. The study looked at that and found that this may not be the way to go because tackling one large debt can be demotivating.

"We're not arguing that debt consolidation is bad, because typically it means people get a lower interest rate," Blanchard told NBC News. "But if I put all of my debts in one big pile, that same payment now seems small and all my efforts seem much smaller in perspective, so people who consolidate have to really work at staying motivated."

Pay the minimum on all of your accounts every month. Then put the rest of what you can afford on your smallest account.

His advice based on this study: Pay the minimum on all of your accounts every month. Then put the rest of what you can afford on your smallest account. Once that one's completely paid off, move to your next larger account and go forward in that manner.

Help is available

Don't sit there paralyzed — get going — because one smart financial move will lead to another. Once you feel like you're making progress, you're more likely to continue making progress.

If you need help getting started, contact a non-profit credit counseling agency. You'll find a list of member agencies in your area on the National Foundation for Credit Counseling website.

A credit counselor can give you an individualized roadmap to follow. They may also be able to put together a program that enables you to pay off your debt with less interest and eliminate those late-payment and over-limit fees.

"Becoming debt-free may take years — depending on the balances owed and how they are paid — so it is important to have a support system that helps you stay on track," said NFCC vice president Bruce McClary. "Talking to a credit counselor can open up possibilities that you may not have considered. You'll get strategies and techniques to pay down your debt faster and more affordably within your individual budget."