Pay Off Small Balances First For Better Odds Of Eliminating All Your Debt

Conventional wisdom says if you have more than one source of debt, you should pay the one with the highest interest rate first since it makes the most financial sense. However, a new study finds people are more successful eliminating debt if they pay the smallest debt first regardless of interest rates.

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Marketing professors from Northwestern University's Kellogg School of Management used a debt settlement database to analyse how 6000 people paid off their credit card debt. They found that the "small victories" approach of closing accounts increased the likelihood of getting out of debt:

"We found that closing debt accounts - Independent of the dollar balances of the closed accounts-predicted successful debt elimination at any point in the debt settlement program," Gal says.

Those who started with paying off small balances were even more successful than those who paid off a larger portion of debt first.

Dave Ramsey, who champions this "debt snowball method", says that getting out of debt isn't about maths — it's about changing behaviour. So even if it doesn't make as much sense financially, it's a better way to motivate yourself towards your goal.

The "snowball approach" to debt [Kellogg School of Management via Dave Ramsey]


Comments

    i disagree i think it should be about the maths, if you are looking to change behavour then to me it would make sense to educate learn about how different interest rates impact things and compound interest. It may be easier to get out of debt by knocking over small debts first and getting the good feeling but thinking logically about your finacial position may help you not get back into it once you are clear.

      While you're correct that it's irrational it's important to keep in mind that often the human mind isn't rational either. Using psychological tricks like this can be a very valuable tool.

    I think this is great advice, we learn through reward and repetition - its the same principle that is used to get people hooked on poker machines. In this case the reward is the success of removing one of the debts that has been weighing on the borrowers mind, by getting rid of a few small ones first the brain has a chance to experience the repetition and embed the experience in memory.
    It would be nice if people operated like machines and operated purely by the math but that is not how it works.

    My brother did this with one business loan, paid off the smaller loan first which has lower interest rate then the larger one. I disagree with the article. I rather pay off the larger debt before small first. Save more money down the track.

    I didn't know about the interest rates on both loans the last minute....

      *I didn’t know about the interest rates on both loans until the last minute*****

    wait- so you have two loans. one is 5,000 at 10%, and one is 1,000 at 5%. Mathematically, I get that paying off the larger one first makes sense, but I can see how the victory of "now I only have one debt instead of two" matters! The point of the snowball method is this: you pay the minimum on each debt, then throw all your extra resources at the smallest one, once that is paid off, you don't take that payment as a bonus, you throw that payment at the next largest debt. And so on.

    So, if the minimum in this contrived example is 50$, and you have 150$ to put to your debts, then it makes sense to put 100 towards the 1000$ debt and the minimum to the 5,000$ debt. after you've paid off the smaller debt, you now have 150 to put towards the other debt. Someone with maths skills and time should work out what it looks like with compounding interest.

    It's a bit more complicated than "pick the smallest one and pay it off for a nice psychological bonus"

    I agree, paying of the smaller debt even tho it might mean a bit more you would have accumulate d in interest gathering on the larger debt doesn't make sense. However having just paid off my credit card with only a couple of hundred dollars, I am no fully focused on the larger loan I have. I have eliminated all the little noise that was the smaller loan, and now am 100% focused on the big one. I feel like I have achieved a minor victory in my battle.

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