When Paying Down Debt....

[Mom2Two]

Do you pay down the credit cards/loans with the lowest balance first or the highest interest first?  What way have you found works best for your families?

[Impish]

We're doing the lowest balance first, which, coincidentally, had the highest interest.

 

Although, a letter I got today informed me that my 'guaranteed low interest' was going up. By over 7%.

 

Not. Pleased.

[ajfries]

It depends on what I lose the most sleep over. When we were paying down debt, I did the smallest balance first, for the "Yeah! We can do this!" factor :) and then went on to tackle the highest interest.

[creekland]

Highest interest.  To me, it makes no sense to go with lowest balance.  If you look at how much it costs per hundred (per month) to borrow the $$, you can get a decent feeling seeing how much more you are saving by paying the highest interest first.

 

The only "deal" with this is to watch mortgage interest as it can be deducted from taxes whereas anything else (interest-wise) can not.

 

But most people are talking credit cards and/or car loans when they ask this question...

 

Then, of course, it can help one stay out of debt if they keep in mind how much they will be paying per hundred per month to go back into debt.

 

I know we opted for getting a "new" old car that we could pay out of pocket rather than something newer we'd need a loan for.  I've been spoiled by not having a car payment in a long time and didn't want to go back to having one even though newer cars were enticing.  Our "newest" is a 2002...

[PinkyandtheBrains.]

Lowest balance on things that were quick to pay down for the feel good factor then highest interest.

 

It's not logical but it helped with motivation.

[Mom2Two]

I am using this debt snowball calculator which gives you a timetable for paying down your debt.  You have the option of choosing to pay off the debts by interest or balance.  I can see the "feel good/accomplishment" factor with the lowest balance first, but can see the benefits of getting those high interest rates taken care of as well. 

 

Here is the website for those interested. It is free and very helpful.

 

http://www.whatsthecost.com/snowball.aspx

[zoobie]

Highest interest. 

[maize]

I have chosen highest interest, but we only had student loans and mortgage. I paid off the higher interest rate student loans, then switched to working on the mortgage. Our remaining student loans are small but the interest rate is so ridiculously low that I don't mind just paying the regular monthly payment. They'll be gone in a couple of years anyway.

 

If you have numerous smaller loans, I think the debt snowball idea can work well. Choose the smallest loans and pay it off quickly, making only minimum payments on everything else. Once that one is gone, you take everything you were paying towards it and add it to the payment on the next lowest valance loan until that too is paid off. Then you take all that money and put it towards the next loan and so on. You keep adding the monthly payment amount of each loan you pay off to the bundle of money you are putting towards the next loan to be tackled, so with each paid off loan you can make a bigger payment on the next.

[Mnemosyne]

For myself, it happens to be the same loan for both.

 

But, highest interest is our priority. Save as much money as we can that way.

[Seasider]

Depends on the gap. If my lowest balance is $150 and my highest is $5K with a higher interest rate, that lower one is just a pesky little fly that I'd like to swat down pretty quickly.

 

If the two debts were closer, say $2K and & 3K, I'd first tackle the one with the highest interest rate.

 

Ideally, I'd look at the largest balance and try to make a call to the creditor to negotiate a lower rate, or maybe take advantage of a balance transfer program. If that were successful at lowering the rate, I would then proceed to tackle the smaller debts first.

 

There really is something to the endorphin rush of paying off a debt, plus the power of the snowball in tackling the next one(s).

[Arcadia]

Highest interest which always happens to be the mortgage. Our car loan was 1.9% and is long paid off.

 

ETA:

No student loans and no credit card debt. Our mortgages have always been high though so paying down principal shorten the loan significantly.

[Susan in TN]

We went by balance lowest to highest for the snowball effect. It worked well for us, particularly since we had several smaller debts to pay off and in our situation 6 months paying a slightly higher interest rate on a larger loan or two was fairly inconsequential. It was a huge boost for me emotionally to be able to add those extra "snowballing" chunks of money onto each subsequent debt.

[AimeeM]

Highest interest, here, unless there is something with a very low balance.

We just paid off all of our credit cards. Some of them carried off a lower balance than, say, my husband's student loans, but the interest rates on the cards were much higher than that of his student loans.

[shawthorne44]

Highest interest, except before I was buying a house.  The ratio that included all loans was the limiting factor on the size of the house loan. So, I paid off the lowest balances first.  

[readinmom]

It's a personal preference thing.  Some say high interest first, others say lowest balance.  I started Dave Ramsey's snowball approach:  tackle the lowest balance first, then add the monthly payment of that bill to the next, etc. 

 

I made a poster with all of the bills, monthly payment, interest rate, and tracked all of the action on the accounts.  In one year, five bills were paid off.  It was rewarding to watch the numbers and creditors disappear.  Our last car payment will be made this month. 

 

If you watch Suze Orman or look at her stuff online, she is adamant about paying off govt. loans first, i.e. school loans.  Unfortunately, my school loans aren't going anywhere for a long time.  The Dave Ramsey approach made more sense for us based on our income/situation. 

 

HTH!

[Paintedlady]

We went by balance lowest to highest for the snowball effect. It worked well for us, particularly since we had several smaller debts to pay off and in our situation 6 months paying a slightly higher interest rate on a larger loan or two was fairly inconsequential. It was a huge boost for me emotionally to be able to add those extra "snowballing" chunks of money onto each subsequent debt.

 

This exactly. We paid down over 100 grand using exactly this method. The idea is to rid yourself of all the smaller loans and as you do you use that money that used to go to the smaller loan and add it to amount that you send to pay off the higher interest.

 

An example would go like this:  

You've got a $500 bill (lowest amount owed) that you normally pay $50 a month.

You've also got a $5,000 line of credit at the bank (not your highest interest or your lowest amount owed) that you normally pay $150 a month.

You've also got a $10,000 credit card (highest interest) that you're paying $350 a month to.

 

You stop paying your regular amounts towards the 2 larger and only pay the minimum for a short time. Let's say the minimum is $100 a month on the big bill and $50 on the second biggest bill. You used to pay $500 a month to those two big bills but now you'll be sending out only $150. You take the difference of $350 and add that to the $50 you're already sending to the lowest bill. So your next payment would be $400 to the smallest bill instead of $50. It would only take a little over a month to pay that one off and be done. It's a boost to cross that off the list and helps keep you motivated.

 

The next month you apply the same principle but as you pay off the smaller bills you add those amounts you used to pay onto the next smaller bill and it keeps "snowballing". Pretty soon you've got 2 bills paid off, etc.... until you can tackle them all. It takes a lot of determination but the reward of living debt free is amazing. Good luck to you!

[shawthorne44]

It's a personal preference thing.  Some say high interest first, others say lowest balance.  I started Dave Ramsey's snowball approach:  tackle the lowest balance first, then add the monthly payment of that bill to the next, etc. 

 

I made a poster with all of the bills, monthly payment, interest rate, and tracked all of the action on the accounts.  In one year, five bills were paid off.  It was rewarding to watch the numbers and creditors disappear.  Our last car payment will be made this month. 

 

If you watch Suze Orman or look at her stuff online, she is adamant about paying off govt. loans first, i.e. school loans.  Unfortunately, my school loans aren't going anywhere for a long time.  The Dave Ramsey approach made more sense for us based on our income/situation. 

 

HTH!

 

What is the logic behind the govt loans first?

[chiguirre]

What is the logic behind the govt loans first?

Student loans aren't dischargeable in bankruptcy, so you can never get rid of them. Even if you're permanently disabled with a huge medical debt, you're stuck.

[gardenmom5]

dh background is finance.  when paying off loans - he always goes for which has the highest interest rate first.

[Kathryn]

Student loans aren't dischargeable in bankruptcy, so you can never get rid of them. Even if you're permanently disabled with a huge medical debt, you're stuck.

 

My student loan can be wiped out if I become permanently disabled.

[Excelsior! Academy]

We did lowest balance.  Fortunately it was at a time when we were being offered lots of 0% interest cc, so we rolled 'em all into one and paid principal only.  Yay!!

[Excelsior! Academy]

This exactly. We paid down over 100 grand using exactly this method. The idea is to rid yourself of all the smaller loans and as you do you use that money that used to go to the smaller loan and add it to amount that you send to pay off the higher interest.

 

An example would go like this:  

You've got a $500 bill (lowest amount owed) that you normally pay $50 a month.

You've also got a $5,000 line of credit at the bank (not your highest interest or your lowest amount owed) that you normally pay $150 a month.

You've also got a $10,000 credit card (highest interest) that you're paying $350 a month to.

 

You stop paying your regular amounts towards the 2 larger and only pay the minimum for a short time. Let's say the minimum is $100 a month on the big bill and $50 on the second biggest bill. You used to pay $500 a month to those two big bills but now you'll be sending out only $150. You take the difference of $350 and add that to the $50 you're already sending to the lowest bill. So your next payment would be $400 to the smallest bill instead of $50. It would only take a little over a month to pay that one off and be done. It's a boost to cross that off the list and helps keep you motivated.

 

The next month you apply the same principle but as you pay off the smaller bills you add those amounts you used to pay onto the next smaller bill and it keeps "snowballing". Pretty soon you've got 2 bills paid off, etc.... until you can tackle them all. It takes a lot of determination but the reward of living debt free is amazing. Good luck to you!

 

This.^   Paintedlady explained it well!

 

[regentrude]

Paying off the loan with the highest interest first makes the most sense financially.

The recommendation to pay off the smallest balance first is supposed to create a motivating effect psychologically, but does not make financial sense - you pay more money in total if you keep the loans with the highest interest rates for the longest time.

[Dory]

We pay off the one with the highest interest rate first. It makes more sense financially.

[OneStepAtATime]

I agree with others, if you need the psychological boost and have a debt with low interest but is very small and can be paid off quickly, then do that, but definitely then take the money you were putting into that and now add it to your higher interest debt payments.  Ideally, if you could roll all your debt into one low interest debt source and just focus on making that one payment each month that would probably be the better option but it depends on the circumstances and this is not always possible.

 

The main thing is sticking to your commitment to pay off debt, being very clear on what the plan is to do that, and making certain that everyone involved in that debt pay off is in agreement and sticks to the plan.

 

[SKL]

Highest interest first.  See if you can move any debt from the high interest to the low interest, low balance ones, but without incurring additional costs.  For example, use the low balance credit cards to buy things you otherwise pay cash for, and use the cash to pay down the high interest loans.  (If you aren't doing this already.)

[An Unexpected Party]

Technically my student loan has a slightly higher interest rate than our new car loan. But, we can claim the interest on our taxes. Also, the debt goes away if I pass away. Most importantly, thanks to a change in the way income is reported when applying for credit, it is now the only item of credit I have only in my own name. Without my own income it is very difficult to get new credit. For these reasons we will pay the car loan down first and will not pay off the student loan early. By the time we are finished with it I will likely be working again in some kind of capacity. 

[Arcadia]

Without my own income it is very difficult to get new credit.

The banks I have accounts in are also looking at the amount of money I have in joint accounts with my husband. I didn't realise that until one of the banks wrote me a letter upgrading my personal credit card again.

I had a secured credit card here as a foreigner, SAHM, with no SSN number. With that, it was possible to build my credit score. I also have supp cards of all my hubby's credit card since I do most of the purchases and the supp cards show up in my credit history.

Just saying that there are other ways to build credit while being a SAHM.

[SKL]

Right, I forgot to mention that you need to look at after-tax interest rates (if applicable).

 

I did pay off a couple of very small low-interest loans first, just because with 25 different loans to pay off (each with a minimum monthly payment), it was easier to knock some of them off and be done with them.  And even checks and stamps cost money.  Not to mention late fees and penalty interest if you screw it up because you have too many balls in the air.

[shawthorne44]

Paying off the loan with the highest interest first makes the most sense financially.

The recommendation to pay off the smallest balance first is supposed to create a motivating effect psychologically, but does not make financial sense - you pay more money in total if you keep the loans with the highest interest rates for the longest time.

 

There something to the psychological angle.  I remember when I bought my house and I got that packet of ... I don't know what it is called.  It assumes you just make your house payment and no extra, and there are columns for amount applied to interest, amount to principal and what the new balance would be.  The packet continued through the life of the 30-year note and was quite thick.  I was appalled at how little of my first payments went to principal.  Seriously, it was under $40.   Because I paid some extra every time, the packet became useless and I reproduced it in excel.  Every time I would think "Nooooo, I can't pay any extra this month" I would look at that excel file and see how much would go to the principle the next month, and add that extra.  Then I would have the HUGELY satisfying task of removing the last payment from the file.  

[unsinkable]

There something to the psychological angle.  I remember when I bought my house and I got that packet of ... I don't know what it is called.  It assumes you just make your house payment and no extra, and there are columns for amount applied to interest, amount to principal and what the new balance would be.  The packet continued through the life of the 30-year note and was quite thick.  I was appalled at how little of my first payments went to principal.  Seriously, it was under $40.   Because I paid some extra every time, the packet became useless and I reproduced it in excel.  Every time I would think "Nooooo, I can't pay any extra this month" I would look at that excel file and see how much would go to the principle the next month, and add that extra.  Then I would have the HUGELY satisfying task of removing the last payment from the file.  

 

amortization schedule

[vonfirmath]

Paying off the loan with the highest interest first makes the most sense financially.

The recommendation to pay off the smallest balance first is supposed to create a motivating effect psychologically, but does not make financial sense - you pay more money in total if you keep the loans with the highest interest rates for the longest time.

 

The difference financially is usually VERY slight. I've run simulations done both ways and on the amounts of debt we had, we were talking about a handful of dollars. At which point the psychological benefit of paying off the smallest balance first REALLY helped us keep the ball rolling and actually FINISH.

 

After all, how many of us DIDN'T know that it costs more to pay interest than not to pay interest? Yet we accumulate this debt anyway.  So we may logically know the truth, but if our heart isn't in it, the debt removal isn't going to happen.  The psychological boost can help it ACTUALLY happen.

 (Plus having fewer bills to pay every month is just easier. Less likely to miss one and rack up late fees.)

 

 

[Erin]

The difference financially is usually VERY slight. I've run simulations done both ways and on the amounts of debt we had, we were talking about a handful of dollars. At which point the psychological benefit of paying off the smallest balance first REALLY helped us keep the ball rolling and actually FINISH.

 

After all, how many of us DIDN'T know that it costs more to pay interest than not to pay interest? Yet we accumulate this debt anyway. So we may logically know the truth, but if our heart isn't in it, the debt removal isn't going to happen. The psychological boost can help it ACTUALLY happen.

(Plus having fewer bills to pay every month is just easier. Less likely to miss one and rack up late fees.)

I've found the exact same thing. Interest first *might* save you a few grand if you have a hundred thousand and several years of debt reduction planned. Otherwise, the difference is negligible.