"Which should I pay off first?"

[Haku]

Questions like this come up regularly, and it has spawned lots of debates I'm sure.

In that light, I just read an article that I thought really put this debate into perspective. This includes the thoughtful responses made after the articles. I recommend reading that as well.

Anyways, here is the LINK. Please try to ignore its title. It may be derogatory, but the article itself is quite good I think.

If you just want the Reader's Digest version, the answer is to pay off the debt with highest interest rate first. The exception is if you somehow value morale boosts more than the differences in amount owed.

[sweeps]

Unfortunately the bad advice is out there. All we can do is try to convince people that the snowball method is generally a bad idea.

[Haku]

I agree, though I do want to clarify something. I don't think there's anything wrong at all with the general concept of snowballing. That is, the part where we pay the minimum on all our debts except the one you're targetting to pay off.

I just don't personally agree with Dave Ramsey's version of snowballing, which meant attacking the lowest balance in favor of the one with the highest interest. On top of that, Dave Ramsey advocates spending additional money to celebrate after paying down each one; further diluting your debt-attacking potency.

However, as one respondant mentioned, it does provide a positive reinforcement for those who need it badly, and for people like that, it could prove to be a more effective motivator in the long run.

While I do acknowledge the "human condition", I paid most of my debts off by attacking the highest interest rate first. You know me, I'm a numbers guy, and seeing the differences in savings, however slight, was motivation enough for me.

[poundwise]

Certainly, the best (mathematically) approach is attack debts based on interest rates. However, it is also mathematically best not to have an established savings account while paying on credit card debt, nor to invest, etc. yet I have both while I work on my debt.

There is something to be said for paying of a debt, even if it was the 'wrong' one. I can especially understand this is the debt is particularly small (just to get it out of the way) or if it is a long-standing debt (a drag on your psyche) or a company/lender that you feel has done you wrong (moral victory to end the relationship that benefits them.)

I'm not disagreeing with the post or the link, only suggesting that sometimes, as in virtually area of life, things that are best 'on paper' may not always be best in real life or for all persons.

[Haku]

You do bring up another interesting point.

Dave Ramsey recommends starting with a baby emergency fund first (say ~1k) before you start attacking debt.

I started by attacking my CC debts first. I didn't bother with a baby emergency fund. My rationale at the time was that I saved more money in the long run this way, and in the event of an emergency, I can still dip back into the CC if necessary.

Of course, the argument is that, if you did that, then you're back into the debt spiral. To which, I can only say that's a big IF as opposed to the guaranteed interest rates that I would've been paying each month from my CC debt. Moreover, because I knew how much more dangerous it was to dip back into my CC debt, it also made me realize what truly consistuted an emergency and what did not.

Fortunately, I never encountered an emergency, so once I paid it off, I closed all my CC accounts and then started saving on a real emergency fund.

I too don't have any problems with how other people pay off their debts. The important point for us all is that we do something about it. To me, this is more along the lines of examining the minutae... if only because it's an interesting subject to me.

[sweeps]

It was my understanding that "snowballing" refers to paying off your smallest (in terms of size) loans off first, then rolling that into the next smallest, etc. Similar to rolling a snowball to make a snowman.

Naturally once you pay off your highest interest loan, you should direct what you were paying towards that towards the next-highest interest loan, and so on.

I understand where Ramsey is coming from -- the psychological aspect of getting rid of a debt. But it would be better to get your motivation some other way. Paying off a smaller 1% loan instead of a larger 20% loan is a really expensive way to motivate yourself.

[debtdude]

Snowballing does refer to pay the smallest debt first and then applying that to the next highest debt. From what I've read and what I've told others, snowballing works well but it works even better when you start with the highest interest rate card first. Is it then still snowballing?

As long as you apply the principles of snowballing to your debts (paying highest rates first), then I'd say it's safe to call it snowballing with the big asterics about interest rates.

Additionally, I've spoken to people who've professed paying off the lowest for the morale boost. I have tried debating these people and showing how much extra money they are paying but it seems that "feel good" feeling is more important to some people.

[sakigt]

I feel more comfortable paying off the TYPES of loans first...regardless of interest rate.

Credit Cards
Personal Loans
Commercial Loans (car payments)
Student Loans
Long term Debt (mortgages)

Now if my car loan is at 12.9% and my credit cards are only 10%, we have an issue, but I bet if your credit card debt was gone your car loan intrest would be lower.

My feelings are if you have debt you should be able to justify it. I can more easily justify why I need a home over something I charged to a credit card. The easier you can justify the loan, the better it is to keep around

[poundwise]

Good point. Revolving credit is a beast.

Haku, I agree that is best to focus all efforts on a target debt but I put a small amount away each month as a hedge against having to dip back into a card. I understand your logic and, in fact, agree with it, but it is nice to know I have some cash if I need it.

As for snowballing, I don't particularly care for the term, but the concept, focusing all effort on one debt and then, when its paid, take that effort+ now and focus on the next is sound and works. The idea of paying lowest balances first v. highest interest first has merit for some people, however, it will cost more in the long-run. I believe sometimes a mix is best. I had a credit card with a small balance (less than $400) that I paid as my first payoff when I started seriously addressing my debt. It was not the highest balance but it was easy to get rid off, gave me a good start psychologically, and also, this payment was due at a time in the month that was bad for me to both remember and have the funds available in time. After that one, I have turned my attention to my second highest balance and highest interest rate.

I will likely pay the remainder of my debts according to interest rate, however, I have a couple of debts that are close (within 2%) in terms of interest rate and yet the minimums asked for are different. If I pay the one with the slightly lower rate, but the higher minimum, then when it is paid, I will have more money to focus on the other and in the end, mathematically, it comes out better to have done so. So, 'always pay higher interest first' isn't necessarily correct every time - though I think it is correct the vast majority of the time and is the best practice overall.

I do think credit card debt takes precedence over loans but usually this is obvious because the interest rate is higher on cards that autos, etc. Sometimes though, loans from American General or CitiFinancial, etc. can have a high rate.

I think it is safe to say that there are many considerations and some advice is better than other but there may be legitimate exceptions to the rules from person-to-person.

[Ima saver]

Whether you tackle highest interest rate, or small amount due, I consider them both to be snowballing.
I guess I was luckier than most. I started saving before I ever got a credit card and into credit card debt. It is a wise thing to teach your children to always have some savings. I tried that with my daughter, but it did not work. I turned her savings over to her when she got married, she drew out every dime and blew it! She has not had a savings account since then. (18 years)

[Haku]

Originally Posted by sakigt

Credit Cards
Personal Loans
Commercial Loans (car payments)
Student Loans
Long term Debt (mortgages)

Hmm, that's an interesting thought! I didn't tackle my debt in terms of what kind it was per se. I mean, I was aware of it, but my primary focus was what could give me the biggest savings down the road if I were to pay that off first. In the end, I also paid stuff off according to your list. Currently, I'm focusing on my student loan....

[flash]

Both sides are valid.

If you pay off a tiny debt, you will "feel good". Get one checked off the TO DO list, so to speak.

But if you are ignoring a beast of a bill...some posts in the past have been 20K on cc, at 22%...you are going to be kicking yourself later.

What we did...if anyone is interested...is BOTH. This is called the FOREST AND TREES plan, basically because you consider each bill AND the entire financial debt, and address both. We laid out all of our bills, chose one to pay off quickly and take a breath, and another giant one to start attacking in pieces. It wasn't the optimal plan from a financial perspective, other than if we worked our tails off on a debt that we couldn't see any progress against, we'd have given up.

As in most things, compromise!