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
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.
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.
"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!
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."
"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
"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
"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."
"Yes, the proof is in the
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