3 Methods to Pay Down Debt (aka Snowballing Debt)
After reading “Choosing the Best Debt Snowball Method” at We’re In Debt, I decided to write up my own snowball method in addition to the two outlined by the King and Queen of Debt:
From the King and Queen:
1. Pay down higher interest first – The interest rate is only part of the equation though. You also have to think about the length of the loan and the amount of the loan. A 6% loan on $5000 over 5 years will cost you $800 in interest. But, a 5% loan on $10000 over 5 years will cost you over $1300 in interest.
2. Pay down the lowest balance first – I can agree that this offers psychological motivation as it makes it appear you’re knocking off your debt faster. However, it doesn’t take into account how much each of your remaining loans is costing you while you’re tackling the lowest balance loan.
From the Clever Dude (me):
3. Pay down the balance with the highest monthly payment, but also take into account the overall cost of the loan – Whew, that was a long one! We have 5 areas of non-home debt. 2 cars, 2 student loans and a credit card payment. The cars cost us twice as much as any of the other payments each month ($400+ per car vs $200 or less per other loan). My thinking is if we knock off the debt with the larger monthly payment, then we’ll free up that much more money to send to the other loans. In our situation, it also happens that the interest rate on one of the cars (about 6%) is our second highest rate (next to one of the student loans). In the end, it’s a win-win on both fronts.
What’s your method for paying down debt?
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For people with lots of small loans (we had probably $50,000 in debt over ~10 student loans, several credit cards, and a car payment), I think the snowball method is ideal, simply because it cuts down on the number of checks you’re writing each month.
But if you’ve got fewer debts, the “fewer checks” carrot may be less of an incentive.
Ultimately I think that all debt payment methods work approximately equally well, so long as the total amount of money going into the debt is the same. Whatever method convinces someone to maximize the debt payments is the right one! I’ll bet if someone sat down and compared each of the debt repayment methods, for a typical debtor, the time to pay off the loans would be about the same (hmm, that gives me an idea for a post…)