There are two, rather well known methods for reducing debt:
Method 1 involves listing your debts smallest BALANCE to largest BALANCE and paying extra towards the account with the SMALLEST BALANCE, regardless of that accounts interest rate.
Method 2 involves listing your debts highest INTEREST rate to lowest INTEREST rate and paying extra towards the account with the HIGHEST INTEREREST rate, regardless of that accounts balance.
I’ve created a poll. If you could use only ONE of the above methods, which method would you choose? Want to tell the world “why” you chose that method? By all means, leave a comment and let us know! Let the voting begin!
{democracy:4}
Psychologically I need to pay something small off to motivate me to keep going. Knicking away at a large balance/high interest rate doesn’t give me the satisfaction of paying off debt, because it never seems to go away.
This is from experience. about 3 times I’ve tried the high interest card first and always failed. Then I heard Dave Ramsey, started with the low balance cards/loans, and have since totally wiped out several of them!
Love the snowball starting with low balance!
I agree with Karen. I am easily discouraged, and I need the satisfaction of seeing a debt paid off. Even if it takes a little longer to start with the smallest debts rather than those with higher interest rates, it feels faster. That’s important to me.
Personally, I would pay the highest interest rate unless the lower interest rate debts were significantly smaller than the highest interest rate debt. However, I can totally understand why some people need the motivation of paying off the smaller debts first.
I’m going with the lowest balance method, now that I actually have money to pay off our credit rather than barely meeting minimums. I used a debt snowball calculator to check the numbers both ways, and while I’ll pay about $120 more in interest doing it the balance method, the kick I’ll get from actually paying off is more than worth that!
If I was going to end up paying several thousand in interest doing it this way, I’d bite the bullet and do it by the interest rate method.
I go with the highest interest. Not that I really recommend it. Since motivation and emotion are a huge factor for people, I say go with the small balances – to a degree. If someone has a $2,000 student loan at 3% and a $40,000 credit card at 30%…I’d cringe at the thought of losing so much by focusing on the small balance.
So I think its just a personal decision. But if you track it on a spreadsheet or something, you can certainly manipulate the graphs to give you a good idea of how good attacking the debt would be. Maybe even make a comparison chart with how much you would be saving vs paying the low balances first? That certainly would motivate me!
I agree with Chris. I’d go mostly for the high interest rate, but if I had one debt that was significantly smaller, I would probably just want to get rid of one.
I voted to pay off the highest interest rate loan. Personally though, there is a caveat that if the difference is less than ~1% then I will pay off the smaller balance just to avoid the hassle of another bill to pay.
For example, my current student loans (at 1.8%) are probably going to be the very last debt that I repay since I have a mortgage at 5.25%. However, I did have a $2000 perkins loan that was fixed at 5% where I decided to just pay it off so that I didn’t have to remember to keep paying it.
I picked highest interest rate and that is actually what I am doing to eliminate my debt. But, my highest interest rate debt is also my credit card and I hate it the most. So, there’s that. If my credit card was a lower interest rate (fixed) than other debts… I might still pay off the credit card first. things to ponder.
IT all depends on your debt, amount owed, current interest etc, if you have a 15,000 dollar balance at 8% and a 6,000 dollar balance at 16%, hmmm I think I will pay off the little one first then throw all my money at the big one, now if you had 15,000 at 14,2 % then of course you would pay off the bigger amount.
Interest was created by the rich to benefit off the poor
Having just finished paying off my $15,000 debt 3 days ago, I don’t have to choose anymore. I’ll tell you what I did.
I payed off the item with the highest interest rate that could be paid in full with the funds available. Mine was a hybrid. I knew my wife and I wouldn’t stick with this without regular victories, so I made the most of it.
We played up the whole deal too. Each time one creditor was paid off, we’d write their name on a balloon, then pop it. Sometimes we let the kids pop them. This helped them see the process and sacrifice as fun.
It also helped by keeping some stats in front of us during the 10-month debt retirement period. Using Excel for our budget and expense tracking makes this easy. We kept 4 metrics:
1. Setting a 1 year goal, and counting down the days.
2. Summing the current months budgeted debt retirement dollars and calculating how long till all are paid off.
3. Summing the current months actual debt retirement dollars and calculating how long till all are paid off.
4. Calculating how much is left to pay.
These provided encouragement by demonstrating progress on those months when no balloons were popped.
To all who have commented… THANKS so much! Keep ’em coming! I’m going to write a HUGE post in a few days and I’ll be referencing your input! If you have a blog, I’ll be sure to link to your site…
So far, the lowest balance method is in a slight lead, but it looks like MOST people are opting for some type of “hybrid” of the two…
For those who haven’t, get to voting!
NCN
As someone who is currently working to pay off debt, I felt the most sense of accomplishment when I paid off my smaller debts first. In my case though, my smaller balances just happened to have the highest interest rates so it worked out well for me.
I voted for highest interest rate first (I’m a numbers guy). Your scenario was that we had to pick only one method. Absent details of the size and number of debts and their interest rates, I would choose highest interest first.
If there was an option for some combination of the two methods I would have probably voted for that. If the smallest debts can be knocked off quickly and remove a couple bills to worry about, I might tackle them first despite being lower interest – especially if there’s not a big difference in rates. But if the difference is knocking one off in 18 months instead of two years, I would go with higher interest rate first. Other factors may be freeing up more cash flow (i.e. size of minimum payments), how my wife feels about it, etc.
In general, get rid of the high-interest debt first. If you need continuing motivation, track the improvement in your financial picture, rather than the number of debts you have. I would use a spreadsheet to track the amount I owed, and the best improvement would be obtained by paying off the highest-interest rate debt first, power of compounding, etc.
However, if you have a lot of debtors there is something to be said for paying the smallest balance, if it’s really small and you can knock it off with a single payment. Just so you don’t have to think about it anymore.
I used this calculator:
http://www.whatsthecost.com/snowball.aspx?country=us
(And you can choose your currency on the right-hand side, if you’re not American!)
Since my debts vary widely in amount but only a by few points in rate, I’m one of those where it doesn’t really matter. Like I said, it only works out to about $120 doing it by balance rather than rate for me.
However, I do “hybrid” a little bit – I try to send in at least a few dollars more than the minimum amount to all of my debts, because I know that “looks good” to them and helps you out. I just mostly commit to the smallest-balance method.
I like the lowest balance method because I agree with Dave regarding the need for motivation in the process along with his observation that personal finance is 80% behavior.
For me personally, I am getting ready to sell some stocks that I recently inherited to pay off a large chunk of my debt (58%) and then I will only have one credit card remaining to pay off and that will probably go fast because of being able to add the other payments to this one.
I don’t really think the lowest vs interest is really the issue. The debt snowball is for people in debt trouble that really need to make a fundamental change in their lives. That means living on the bare minimum, selling belongings that are too expensive for their income, and putting every extra dollar towards their debt. In this scenario differences in interest rates really don’t matter very much. Its small but there is also the risk associated with open accounts, late fees, creditor errors, hidden charges etc…
Wow, 140 votes and it’s pretty much even! I went with lowest balance first, though if the balances were close, I’d actually choose the one with the higher rate. There’s just something so gratifying about paying off a debt!
One other comment I had –
I voted for the “higher interest rate”, but one thing I do to see progress is that in my personal net worth spreadsheet, I maintain the amount of interest paid in a given month. So, I can see that as I pay off higher interest rate debt, my interest paid per month continues to decrease.
Generally highest interest rate, but if I had a small debt at a lower percent, I’d probably just pay it off for simplicity’s sake.