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    Pay Off Smaller Debts First

    Courtesy of Wixx and our sister site <a href="http://www.debtreduction101.com">Debt Reduction 101</a>

    You have probably heard the tried and true theory that the quickest way to pay off debt is to pay the highest interest bills first. There does come a time, however, when it is feasible to pay off smaller bills first - particularly certain credit cards with high minimum payments. For example let's suppose that Johnny has been building credit card debt on four separate accounts and now has the following accounts. Leaving aside the option to transfer funds from his higher interest cards to the lowest, for another article when I can devote more time to that particular topic, let us examine the possibility of reducing Johnny's debt.

    <center> <table bordercolor="#336699" cellspacing="0" cellpadding="4" width="475" border="1" style="font-size:7pt"><tbody><table border><tr><th>Account</th> <th>$ Amount</th> <th>% interest</th><th>min. payment</th></tr><tr><th>A</th> <th>$3000</th> <th>16%</th><th>$60</th></tr><tr><th>B</th> <th>$2000</th> <th>15%</th><th>$40</th></tr><tr><th>C</th> <th>$300</th> <th>13%</th><th>$20</th></tr><tr><th>D</th> <th>$700</th> <th>15%</th><th>$20</th></tr></table>
    </center>

    Supposing that Johnny has come up with $250 a month to use for debt reduction, it would actually be better for him to pay off credit card C first and then use that extra $20 a month to help pay off card D next. This will have credit cards C and D paid off in 4 months and now he is paying off his highest interest account A with an extra $290 each month. This makes sense only because the C and D accounts have high interest themselves.

    If account D was only 10% interest it would not be better to pay it ahead of A or B. The length of time required to pay off the smaller debts is very important as well. If account D had more than just a few months of reduction payments on it, the money would do more work to tackle the large A account first.

    Paying off the higher interest rates is the best way pure and simple because you save interest by paying on $250 less the next month, but if you have a few small debts that can be tackled in a few months, and in particular if they have higher minimum payments, paying them off first is a great alternative.

    The reason that this can be good is that it gives a sense of accomplishment. We are an instant gratification society, and even though he will save over $1000 in interest by paying off account A first, Johnny does not feel that he is accomplishing anything until he is writing one less check per month. Paying off account C so soon makes Johnny feel good that he is getting his debt under control (and thus will continue to pay down debt and not give up on the strategy). Then when he is working with that extra $20 to use on the accounts with larger dollar values attached to them, his confidence is again boosted.

    Adding a car loan to this increases the complexity drastically. Auto loans are typically lower interest than credit cards, but have much higher monthly payments. These higher payments mean that paying this loan off sooner could double the amount of monthly funds that Johnny has available to knock out that credit card debt, but paying that money on the much higher interest credit cards instead reduces the interest paid over the length of the credit card repayment schedule and is the best alternative. Unless your car loan has a high interest rate, it is best to pay that extra money on credit card debt than it is to double up that car payment.

    As for mortgages, the overall amount of the loan is so large, and the interest rate <i>should</i> be low enough to make this the final step of the debt reduction process, in my opinion. Once the credit card debt is paid off, the money can then be sent to pay off the mortgage quicker.

    #2
    Re: Pay Off Smaller Debts First

    fyi, we did this with our tax return. we paid off the car (2800) and i applied my monthly car payment to the student loan. Although tough to stay disciplined, we will be done with the student loan this month after paying more than 400/mo. and i will sleep well at night.

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      #3
      Re: Pay Off Smaller Debts First

      This looks like a good place to start. I think we'll try it. It was getting frustrating with several loans and getting nowhere.

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        #4
        Re: Pay Off Smaller Debts First

        The debate over "smallest balance first" versus "high interest first" seems so sticky at times due to so many little variables at play that varies from individual to individual.

        One of those variables that I also think is worth considering is how much can one set aside for debt elimination? I've heard that some were so tight on their budget that they believed they had no choice but to pay off the smallest first.

        Those who can afford $100 extra a month (at the very least) just for the sole purpose debt reduction may be better served to focus more on high interests first.

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          #5
          Re: Pay Off Smaller Debts First



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            #6
            Re: Pay Off Smaller Debts First

            Honestly, I believe the biggest thing is just to start on the debt reduction. Man, as an update, as of today we are totally debt free except our house. So corny--hubby and I clicked the "send payment" button together on the last student loan payment, but what a sense of accomplishment!

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              #7
              Re: Pay Off Smaller Debts First

              Congrats to you, Lukkyb22!! That is awesome!!

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                #8
                Re: Pay Off Smaller Debts First

                Thanks, Lilly. And I know if we can do it, anyone can!

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                  #9
                  Re: Pay Off Smaller Debts First

                  Originally posted by Broken Arrow
                  The debate over "smallest balance first" versus "high interest first" seems so sticky at times due to so many little variables at play that varies from individual to individual.

                  One of those variables that I also think is worth considering is how much can one set aside for debt elimination? I've heard that some were so tight on their budget that they believed they had no choice but to pay off the smallest first.

                  Those who can afford $100 extra a month (at the very least) just for the sole purpose debt reduction may be better served to focus more on high interests first.

                  The three options for debt reduction seem to be:

                  1/ The traditional idea of debt consolidation at a lower interest rate.

                  2/ Pay off the highest interest rate debt first.

                  3/ Pay off the shortest term loan first.

                  Each of these strategies have good points and bad points. I've been researching and developing software that will do comparisons of these strategies for people. It's early days but a few things are already becoming clear.

                  All three options have advantages provided you know what you are doing and why.

                  For fast removal of debt, option 3 where you pay off the smallest loan and then then put the payments against the second smallest loan seems to be the fastest and cheapest option.

                  Option 2 works almost as quickly depending on the lengths of the loans.

                  Option 1 where you refinance has the advantage of reducing the overall interest rate. Unfortunately it is very easy to allow short term ebt such as credit card debt to turn into long term debt using this option.

                  I look forward to in a few months time when it will be easier to look at a situation and give exact options.

                  I know at one time I nearly ruined my cashflow when I was trying to pay off too many things at once.

                  Enjoy Your Money
                  The Budget Man

                  www.PersonalityBudgeting.com
                  The budget system that works

                  Comment


                    #10
                    Re: Pay Off Smaller Debts First

                    Originally posted by lukkyb22
                    So corny--hubby and I clicked the "send payment" button together on the last student loan payment, but what a sense of accomplishment!
                    I've been there. When I sent in the check for the last payment for my husband's student loan, I wrote "Good riddance!" in the memo, and wrote the $500 check out so it said, "Five hundred dollars and no sense"!

                    Hey, they accepted it!!

                    ~ Jenney

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                      #11
                      Re: Pay Off Smaller Debts First

                      I have been talking with a lot of people about debt reduction strategies. It seems that the hardest step is not the first step but the 10th, 11th 12th etc. The challenge is keeping it going.

                      I find that the only way I will keep going doing something is to make it a routine. That's good, but if I can make it a routine that is automatic I will always succeed.

                      I put debt reduction on automatic by calling it a bill and having it come out automatically from my bill account. It works for me.

                      I have most of my bills as routine and never have to worry about them.

                      Enjoy Your Money
                      The Budget Man

                      www.PersonalityBudgeting.com
                      Automating your budget so it happens

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                        #12
                        Re: Pay Off Smaller Debts First

                        Well, I am down to one CC payment so it is a moot point.

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                          #13
                          Re: Pay Off Smaller Debts First

                          When you set up your plan, you are concentrating on only 1 debt at a time. Meanwhile, you continue to make your minimum payments on the other debts and by the time you get one debt paid off, you see the next one that you will pay off already less because of your payments. We did it and it works, but you have to have a plan. We made a chart where we could see where we were and we were always able to see our goals. We would put stars on them, date them with the pay off date. It is important to get rid of the smaller debts. It's more psychological than anything else. It's important to see something working for you pretty quickly. Then you can take that payment and then add it to the next one and so on and so on. It's a great feeling.

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                            #14
                            Re: Pay Off Smaller Debts First

                            neatdesign, that is really cute!

                            I think whatever system motivates someone to work on their debt is what they should be using. At other points in my life, I have used the pay the smallest first just because I was overwhelmed. Now, I have no small debts and just an icky large student loan so that's where I apply all my efforts. Someone else said just getting started is the key and I agree totally

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                              #15
                              Re: Pay Off Smaller Debts First

                              Originally posted by fairy74
                              neatdesign, that is really cute!

                              I think whatever system motivates someone to work on their debt is what they should be using. At other points in my life, I have used the pay the smallest first just because I was overwhelmed. Now, I have no small debts and just an icky large student loan so that's where I apply all my efforts. Someone else said just getting started is the key and I agree totally

                              It's amazing how important motivation is. For weeks I've been going to trim the fruit trees in the backyard. Then last week the wife told me that she had seen the first fruit flies of the season. All of a sudden I had to trim the trees so she could protect the fruit. (Once the fruit is fly struck it is useless)

                              I act when I have motivation.

                              It's the same with debt and budgeting. If there is no motivation to get rid of debt then the debt grows.
                              The Budget Man

                              Discover how to be motivated with your budget
                              www.PersonalityBudgeting.com

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