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DEBTSMART® Household Math™: Debt Snowball (Myth or Magic): Paying Back Lower-Balance Cards First
by Scott Bilker

Scott Bilker is the founder of DebtSmart.com and the author of Talk Your Way Out of Credit Card Debt, Credit Card and Debt Management, and How to be more Credit Card and Debt Smart. Send your questions about money, credit, loans, mortgages, or debt, to him at: Scott Bilker, PO Box 563, Barnegat, NJ 08005-0563 or online at: http://www.debtsmart.com/askscott



David Sheepsley has two credit cards with balances. Card A has a balance of $8,000 at 19.8% and minimum payments of $160 per month. Card B has a balance of $6,000 at 5.9% with minimum payments of $120 per month. David has a total of $400 per month to use for repaying his credit cards. What's the better plan for David?

1)

Pay the most money possible per month to the lowest-balance card (B) first and make minimum payments to the highest-balance card (A) until the lower-balance card (B) is paid off. Then send the entire payment of $400 to Card A until that debt-repayment is completed.

2)

Do the reverse. Pay the most money possible per month to Card A and make minimum payments to Card B until Card A is paid off. Then send the entire payment of $400 to Card B until that debt-repayment is completed.

SOLUTION

Paying the lowest-balance first is sometimes called a "Debt Snowball." The problem is that you're rolling the snowball uphill! Here is the quote directly from those who propose this foolish plan, "DEBT SNOWBALL: List your debts in descending order with the smallest payoff or balance first. Do not be concerned with interest rates or terms..."

Many so-called "experts" suggest this ridiculous plan for paying the lowest-balance card off first for psychological reasons, claiming it gives you quicker feedback and allows you to be more likely to stick to the plan."

That strategy is simply wrong! That is, unless you like paying extra money to your creditors.

Here's why:

DEBT SNOWBALL PLAN: PAY THE LOWEST BALANCE FIRST

Card A: $8,000 at 19.8% at $160 per month Card B: $6,000 at 5.9% at $240 per month Total payments equal $400 per month

Card B is paid off in 26.74 months. At that point in time, Card A has a balance of $7,068 to which we start applying payments of $400.

Card A is paid off in another 21.06 months.

Total payoff time is 26.74+21.06=47.80 month

Total payoff cost=47.80 x $400=$19,120

That's $19,120 out-of-pocket cost for the Debt Snowball.

PAY THE HIGHEST INTEREST RATE FIRST

Card A: $8,000 at 19.8% at $280 per month Card B: $6,000 at 5.9% at $120 per month Total payments equal $400 per month

Card A is paid off in 38.96 months. At that point in time Card B has a balance of $2,124 to which we start applying payments of $400.

Card B is paid off in another 5.39 months.

Total payoff time is 38.96+5.39=44.35 months

Total payoff cost=44.35 x $400=$17,740

That's $17,740 out-of-pocket cost paying the highest interest card first.

CONCLUSION

"Debt Snowball" costs $19,120 "Pay highest rates first" costs $17,740

Additional cost for the Debt Snowball is $19,120-$17,740=$1,380 (because it takes over three months longer to repay the debt using this method).

That's $1,380 more to follow that "expert" advice of paying the lowest balance first. Don't do it! Pay the highest interest rate cards first, no matter their balance! That's being DebtSmart!

If anyone needs psychological reassurance, they'd still be better off paying the highest rates back first because they would have and extra $1,380 to spend on a psychologist!


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Reader comments about this article:

"I answered it correctly! And that it debunks a myth about paying off the smallest balance first. I was very surprised when I read a well-known expert in financial advice had told someone the same thing. I asked him if it wouldn't be better to pay off the highest interest first. I haven't gotten an answer yet! Paying off something with higher interest is like putting money in the bank. Very informative and always entertaining." 
--Sue Sheffler

"I liked it very much. It makes people think and is a common situation for most people with credit cards. 'Which order of payment would be the least expensive for me to pay off these darn credit cards or other accounts?' I just bought the book "Talk your way out of CC debt". I read something in the book that really made me think, I would really try to market the book (and website) to senior citizens who may be getting gouged by the CC companies with high APR's and not be aware of it. This was a point made in the book and it would be a great benefit for them to know if they're getting fair APR's from the CC companies." 
--Keith Pounds

"This was a very interesting and timely question for me and I answered as per some young CitiCorp reps. who were trying to sell me on this concept; pay smallest first and then add to largest. I do have a credit card with a high interest rate and a couple smaller loans with much lower rates. This has proven their sales stategy wrong." 
--Douglas Johnston

"It was a great quiz. But I think either answer would have worked. Depends on the person who is in debt. I don't agree with the answer. Most people who are in debt would see better satisfaction in wiping out one bill at a time. The interest saved in the long run by paying the higher bill would be a mute point. I got out of debt by snowballing from the lowest to the highest and it worked for us. I may have had an additional $500 in interest but I think I paid it off quicker than if I had done it higher balances/interest rate first." 
--Penny

"Yes, the proof is in the numbers!!" 
--David P. Paquette, Jr.


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