The Best Debt Payoff Method

By Mark
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    When it comes to debt payoff, there are competing theories as to which is the best way to do it. Many ascribe to the “debt snowball method” where you start by paying off your smallest balance first. The other popular method is to pay off the balances with your largest interest rate first.

    I took an in-depth look at both debt payoff methods including a couple examples. But before I get to the results – the most important thing in paying off debt is that you make it a priority! You will fail 100% of the time if you're not committed to becoming debt free.

    become debt free

    The Best Debt Payoff Method

    Debt Payoff is a big deal these days. A quick glance at the financial situation of the average American family will explain why:

    • The total credit card debt is $747 billion
    • Total auto loan balances are $1.14 trillion
    • Total student loan balances are $1.28 trillion

    That's a lot of debt people! But you don't have to be a contributing statistic to our country's debt epidemic. Speaking from experience, getting that debt paid off is awesome. And the most surefire way to get it done is to HAVE A PLAN.

    For this debt payoff method comparison, I created a couple “portfolios” of debt. And I also created a gigantic spreadsheet to help me create debt payoff plans using both the debt snowball debt payoff method and the highest interest rate first debt payoff method.

    Let me guess… you're interested in me sending you the spreadsheet so you can create your own debt payoff plan? Trust me… you don't want it. It's kind of a mess. But I'll go one step better and provide you access to a tool that will give you your own personalized debt payoff plan! Click HERE if you're interested.

    Get access to debt payoff plan
    Ok – back to the scenarios I used for this study. One of the scenarios is somewhat realistic, although that auto loan rate is crazy high (more on that later), while the other scenario is very wacky.

    Here's the first debt portfolio (somewhat realistic):

    • Credit Card – Balance: $2,500, Interest rate: 10.00%
    • Student Loan (Public) – Balance: $9,000, Interest rate: 5.00%
    • Auto Loan 1 – Balance: $20,000, Interest rate: 7.00%
    • Auto Loan 2 – Balance: $8,000, Interest rate: 13.00%
    • Sum of minimum payments: $550
    • Extra monthly money available for debt: $200

    Here's the second debt portfolio (wacky):

    • Credit Card – Balance: $2,500, Interest rate: 2.00%
    • Student Loan (Public) – Balance: $9,000, Interest rate: 11.00%
    • Auto Loan 1 – Balance: $20,000, Interest rate: 12.00%
    • Auto Loan 2 – Balance: $8,000, Interest rate: 8.00%
    • Sum of minimum payments: $550
    • Extra monthly money available for debt: $200

    The Debt Snowball Method

    Under the debt snowball debt payoff method, you ignore interest rates and pay off your debts according to the size of the balances, starting with the smallest balance first. Any extra money that you find in your budget goes towards getting that first debt paid off.

    Once the first debt is paid off, any money in your budget that was going towards paying off that debt will not be applied to the next debt to be targeted. Continue “snowballing” previous debt payments into the next debt until you have an avalanche of money going towards that final debt to pay it off once and for all. This simplified chart helps illustrate the method. It is assumed that $650 is available each month for debt payments.

    debt payoff

    I hate to talk math at y'all, but this isn't too hard, right? I did take this interest rates out of this to make the numbers nice and round… if they were included, the above debt balances would be slightly increasing from month to month. But I hope you get the point.

    Pros and cons for the snowball method

    • Pro – total number of debts reduced quickly.
    • Pro – small emotional victories can help motivate.
    • Pro – easy to follow.
    • Con – might take longer to become debt free.
    • Con – you might pay a little more in interest.

    Largest Interest Rate First Debt Payoff Method

    Many personal finance experts recommend paying off the largest interest rate debts first, and then tackling the smaller interest rates. The reasoning is fairly simple – that quicker you pay off high interest debt, the less you will be paying in interest.

    Mathematically, this makes perfect sense. Less interest paid means more principle paid, which should mean that they get paid off faster, right? Correct.

    Using this method, you should still “snowball” your debts. When one debt is completely paid off, you should always take what you were paying on that one and apply it to the next debt in line. Technically, both methods should involve “snowballing”… but when finance nerds say “snowball method”, they are generally referring to paying off small balances first.

    Pros and cons for the snowball method

    • Pro – the mathematically quickest way to debt freedom.
    • Pro – less interest paid.
    • Con – carry larger number of debts for longer.
    • Con – possibly more difficult to manage.

    The Comparison in Action!

    Portfolio 1

    I will first show you just how long it will take to pay off this debt if you didn't apply any other money except the minimum payments and don't snowball your payments. In that case, it would take you 9 years, 5 months, and $53,058 to pay off this portfolio of debt.

    Using the debt snowball debt payoff method and applying an additional $200 a month on top of the minimum payments, debt portfolio 1 would be paid off as follows:

    • Credit Card – Balance: $2,500, Interest rate: 10.00% – Payoff date: Month 11
    • Student Loan (Public) – Balance: $9,000, Interest rate: 5.00% – Payoff date: Month 45
    • Auto Loan 1 – Balance: $20,000, Interest rate: 7.00% – Payoff date: Month 64
    • Auto Loan 2 – Balance: $8,000, Interest rate: 13.00% – Payoff date: Month 31
    • By paying $750 total each month, this total debt of $39,500 will be paid off in less than 5 years, 4 months.
    • Total paid: $47,428

    Using the highest interest rate first debt payoff method and applying an additional $200 a month on top of the minimum payments, debt portfolio 2 would be paid off as follows:

    • Credit Card – Balance: $2,500, Interest rate: 10.00% – Payoff date: Month 31
    • Student Loan (Public) – Balance: $9,000, Interest rate: 5.00% – Payoff date: Month 63
    • Auto Loan 1 – Balance: $20,000, Interest rate: 7.00% – Payoff date: Month 56
    • Auto Loan 2 – Balance: $8,000, Interest rate: 13.00% – Payoff date: Month 27
    • By paying $750 a month, this total debt of $39,500 will be paid off in less than 5 years, 3 months.
    • Total paid: $47,055

    Using this somewhat realistic debt portfolio, paying off you will save $373 over the course of 5 years, and pay the debt off one month sooner. But take a look at how long you have to wait until even a single debt is paid off – over 2 years!

    Is it worth it to tackle the highest interest rates first to get that more mathematically pure debt payoff? It's up to you. But here's the thing, it usually makes almost no difference at all. Here's why – smaller debt balances tend to have higher interest rates anyway. So no matter which method you choose, the order that you pay off debts won't vary too much. Even in this scenario, I had to create a high balance debt with a super high interest rate just to show any kind of significant difference between payoff dates.

    That said… if your debt balances have super wacky interest rates, then you might want to consider paying off the highest interest rate balances first. Scenario 2 illustrates this.

    Portfolio 2

    Paying just the minimum payments and not snowballing debts, it would take 11 years, 6 months, and $61,794 to pay off this debt.

    Using the debt snowball debt payoff method and applying an additional $200 a month on top of the minimum payments, debt portfolio 2 would be paid off as follows:

    • Credit Card – Balance: $2,500, Interest rate: 2.00% – Payoff date: Month 11
    • Student Loan (Public) – Balance: $9,000, Interest rate: 11.00% – Payoff date: Month 47
    • Auto Loan 1 – Balance: $20,000, Interest rate: 12.00% – Payoff date: Month 73
    • Auto Loan 2 – Balance: $8,000, Interest rate: 8.00% – Payoff date: Month 29
    • By paying $750 total each month, this total debt of $39,500 will be paid off in less than 6 years, 1 months.
    • Total paid: $54,061

    Using the highest interest rate first debt payoff method and applying an additional $200 a month on top of the minimum payments, debt portfolio 2 would be paid off as follows:

    • Credit Card – Balance: $2,500, Interest rate: 2.00% – Payoff date: Month 53
    • Student Loan (Public) – Balance: $9,000, Interest rate: 11.00% – Payoff date: Month 70
    • Auto Loan 1 – Balance: $20,000, Interest rate: 12.00% – Payoff date: Month 58
    • Auto Loan 2 – Balance: $8,000, Interest rate: 8.00% – Payoff date: Month 66
    • By paying $750 a month, this total debt of $39,500 will be paid off in less than 5 years, 10 months.
    • Total paid: $52,457

    The savings in this method are $1,604, and it will be paid off 3 months sooner. Those savings are definitely more significant, but still not as much as you might think.  I had to create a ridiculous scenario to get this result where the balances and interest rates are inversely related… although I suppose having 0% on a credit card for a limited period of time is quite common.

    The Verdict

    The biggest take away from this calculation is that either method you choose, you've got to snowball your payments! In the first scenario, adding $200 a month and snowballing payments gets you debt free 4 years sooner and you will pay about $6,000 less in interest. Adding just a small amount of extra money each month will make a huge difference in getting this debt paid off.

    I'm not going to advocate strongly for either method. Use whichever method will give you the greatest probability for success. If getting those early wins of paying off smaller debts motivates you to keep going, then go with the snowball method (smallest balances first). That's what worked for me. If the thought of tackling your debt using a more mathematically pure method motivates you, then use the high interest rate first method.

    Whichever method you choose, “snowballing” those debts is a must. When you're in ‘get out of debt' mode, just throw everything you have at it, be patient, persistent, and watch your debts melt away.

    Interested in you own personal debt payoff plan? I've got something that can do just that! Click HERE to get access to a calculator that will give you a personalized debt payoff plan using either method!

    Get access to debt payoff plan

    The Snowball Method vs. The Highest Interest Rate Method - find out who comes out on top for the best debt payoff method! PLUS - your own payoff plan!

    COMMENTS

  • One benefit of paying off small debts first is that if you have an emergency pop up you are often better able to absorb it without going into debt or continually emptying your emergency fund. The first method may take an additional month but your cash flow improves a bit quicker and allows a bit of breathing room.

  • The share buttons on the left side of the website cover up the text. Is there anyway to shrink or get rid of those buttons so I can read your posts?

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