I am a big fan of micro-payments. If you are unfamiliar with the term, a little background information might help. Back in 2005, while working to pay off my debt, I decided to try a little experiment. Instead of sending just one payment to my credit card company each month, I started to send several. I called these small payments micro-payments. At one point, I actually sent $5 a day (via online bill-pay) to one credit card company, just to see if the system would work. (I don’t recommend sending micro-payments quite that often, and I only did it for one month, as proof-of-concept.) At the end of the month, my balance was reduced by an additional $150, above and beyond the amount of my regular payment.
Throughout this article, whenever you see the word month, feel free to substitute the words billing cycle.
Micro-payments are simply extra payments, made throughout the month. They are designed to reduce a credit card balance and to keep one’s mind focused on the debt reduction process. These extra payments are additional payments, and are only made after minimum monthly payments are made (on time), to each and every creditor. Also, micro-payments are not intended to replace debt snowball payments, but are intended to compliment those payments.
Perhaps an illustration is in order -
Assume that you have three credit cards that you are trying to pay off -
Credit Card A with balance of $5000 @ 10%
Credit Card B with balance of $6000 @ 12%
Credit Card C with balance of $8000 @ 8%
Further assume that you are using the debt snowball method to reduce your debt -
You will make minimum payment + extra payment to Credit Card A
You will make minimum payment to Credit Card B
You will make minimum payment to Credit Card C
Remember, if you use the typical debt snowball, you will pay off debts, starting with lowest balance first, regardless of interest rate. If this method does not suit you, you might consider the debt deluge – a modified version of the debt snowball. Use online bill-pay to simplify the process and save on postage. When making minimum payment and extra payment to Credit Card A, feel free to send one payment, equal to their combined total.
After making all minimum payments and your extra payment, it is time to focus on micro-payments. Throughout the month, look for opportunities to send in micro-payments, as you earn additional income, receive monetary gifts, or spend less than anticipated in certain budget categories.
Assume that in Week #1 –
You receive $25 as a birthday gift
You sell a few books online, netting $15
You ride to work with a friend, saving $10 in gasoline
At the end of Week #1, you have the following options -
You could spend the $50
You could save the $50
You can could send the $50, as a micro-payment, to Credit Card A
Since you have already sent in your minimum payments (on time) to all creditors, and you have already sent your scheduled (and budgeted for) extra payment, any of these options is available to you. (We will assume that you already have a small cash reserve set aside for small emergencies.) And, if you are uncomfortable sending the entire $50 as a micro-payment, you could send just a portion of the $50.
By now, you might be wondering -
Why worry with micro-payments in the first place?
Why not just one, larger, extra payment at the beginning of the month?
Why not send just one, larger, extra payment at the end of the month?
Not only am I a rational being, but I’m also an emotional being. As such, it’s important for me to remain engaged – focused – on any project on which I am working. When it comes to debt reduction, this was doubly-important. Not only was I trying to do away with 15 years of negative behaviors, I was also trying to replace those behaviors with positive behaviors. By constantly looking for ways to save money – I remain engaged. By thinking about ways to earn additional income – I remain focused. Just thinking about ways to save a little more or earn a little more, so that I could make a micro-payment, kept me emotionally involved in the debt reduction process, in a way that the one-payment-per-month-method never would have.
There is also a mathematical reason for sending micro-payments throughout the month. Most credit card companies use the average daily balance for calculating how much interest they charge. Making payments as soon as is possible will lower the average daily balance, thereby reducing the amount of interest owed. If you save up an additional payment and the send it when you get your next bill, you might be paying unnecessary interest. In other words, if you receive $50 as a birthday gift, and you have no real need for it, send it in as soon as is possible, thereby reducing your average daily balance.
There is an additional reason for using micro-payments, one that was very important to me while I was getting out of debt. I like to set goals – ambitious goals. There are times, however, when my goals are a bit too ambitious. For instance, let’s assume that my budgeted extra payment to Credit Card A is $500. For some, $500 might be a reasonable amount for an extra payment. For others, $500 might be a stretch. So, instead of sending in $500 at the beginning of the month, there might be times when it would be better to send in a $100 extra payment, and then, throughout the month, send in four additional $100 micro-payments.
This might be true, especially, for those who are paid on a weekly basis, those who have irregular income, or those who are new to budgeting. It is very easy, especially in the early days, to over-estimate how much money you actually have for debt reduction. We do not want to find ourselves, at the end of the month, with a need to use a credit card. By spacing our micro-payments out, over a full month, we can better judge if our budgeted-for extra payment is practical. If we find that coming up with $500 was easy, then we might want to send the full amount at the beginning of the month. If we find, on the other hand, that coming up with $500 was impossible, we might want to budget $250, and the use micro-payments to send in extra, as we save it or earn it.
Please note: Sending in a larger amount, earlier in the month, will almost always lead to a lower interest charge (provided the credit card company uses the average daily balance method for calculating interest). Also, no matter what method you use, it is imperative to make minimum payments on time, to all accounts.
There are a few more things about micro-payments to keep in mind -
When sending micro-payments, be sure that you can comfortably keep track of them. Online access to both your checking account and your credit card accounts is a must. Also, the payments that I was making were initiated from my checking account to my credit card account. In other words, these were payments, sent by me, via online bill-pay. I did not use the credit card companies service, whereby they will deduct payments from a checking account. For me, I never felt good about giving my credit card company, or any other company for that matter, access to my credit card account. Four micro-payments per month, one each Monday, worked well for me.
Micro-payments can also be sent to pay off mortgages, automobile loans, and almost any other type of debt. Just check with your creditors and ask them where to send additional payments and how to label those payments. I always labeled mine – apply to principal.
It’s always important to have enough money to make all minimum payments. In other words, don’t send every extra penny that you have in August, if in September, you aren’t going to have enough to make your minimum monthly payments.
Now that I am debt free, I no longer make micro-payments, but I do make micro-deposits. At the beginning of the month, I set aside a budgeted amount for savings. Then, throughout the month, I look for ways to save money or earn additional income. Once or twice a month, I make additional micro-deposits to my savings account, thereby saving more, each month, than my original budget predicted. This also works when making contributions to a Roth IRA.
Please be aware, some credit card companies may limit the number of payments that they will process in a given month. Be aware of your credit card companies policies. Also, be sure that you are using a free online bill-pay service to send your micro-payments, avoid spending money on postage, and verify that your credit card company is receiving extra payments.
I would love to hear your success stories with using micro-payments. Also, if you have any additional thoughts or tips, leave a comment and let us know about them. Let’s eradicate some debt – so that soon we can all enjoy being debt free!