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The Correct Way to Pay Off Personal Debt: The Debt Avalanche

This article was written by in Best Of, Debt Reduction. 166 comments.


When it comes to mathematics, certain facts are universally agreed-upon. For example, regardless of your culture or educational system, you must agree that one plus one equals two unless you mistakenly fall for an invalid proof. When dealing with money, why are people inclined to believe that one plus one does not equal two?

If you have a certain amount of money available to pay off a portion of your credit card debt each month, even if that certain amount changes, there is a mathematically correct way of paying off that debt. You can call this approach the Debt Avalanche. It is similar to Dave Ramsey’s popular “debt snowball” method, with one small but important detail: With the Debt Avalanche you will pay off your debt faster and pay less total interest to banks and lenders.

The simple calculation for the Debt Avalanche requires only the interest rates for each debt account. This assumes that all debt accounts have the same tax liability, but if that’s not the case, determine your interest rate after taxes for this calculation.

Step 1. Order your debts from highest interest rate to lowest. You may find credit cards at the top of the list. It’s typical to see interest rates from 10% to 20% or more. Credit cards offered by stores often have the highest interest rates, so you might find these at the very top. Watch out for promotional rates ending, which they may do on the date promised when you enrolled, or earlier. Card issuers also re-evaluate their customers every so often, and will not think twice about raising your rates midstream. Note that if your credit improves, they will not magically lower your rates. While lenders will notify you if they intend to raise your rates, you may have missed the notice.

Your mortgage and home equity loan may be the next debts in line. It’s important for your list to capture every debt for which you make a monthly payment. Student loans may be the last on the list, particularly if you qualify for tax credits. The Debt Avalanche formula won’t work properly if it covers only a portion of your debt, so consider all accounts.

Order your list from the highest interest rate (after tax) to the lowest. You may have noticed we didn’t factor in your account balances in the above formula. That is because your individual account balances are irrelevant. The issue solved by the Debt Avalanche is the best way to pay off your total debt with all available funds.

Step 2. Pay the minimum to all debts every month. If you’re writing down your list, or using a spreadsheet like Excel, add a column next to each debt to list its minimum monthly payment. This is the amount you will pay towards each debt, except for the one account listed at the top of the list.

Another column should list the payment due date if it is relatively static from month to month. For example, my credit card payment is due on the last date of almost every month, so I would write “30.” This would indicate to me the last date of every month. Your payments should always arrive before the due date. In fact, in some cases, you can reduce your total interest paid by paying weeks in advance of your due date.

Step 3. To your debt with the highest interest, send all extra available cash. If you have an emergency fund or money available from your savings account, this step is simple. Since it’s unlikely that you can earn more in savings than you can “earn” (reclaim) by paying off your debt, all your unused income after paying expenses (necessary and discretionary as you see fit) should be dedicated towards the debt account with the highest interest rate.

Step 4. Repeat every month. You cover all your bases by ensuring every creditor receives the minimum payment, but you hone in on only your debt with the highest interest. Once a debt account has been eliminated — and it may not be the account at the top of the list if other balances are smaller — remove it from the list and re-order if interest rates have changed.

It’s that simple. This is mathematically the best method for paying off your personal debt. No other method will get you out of debt faster and save you as much money.

Despite the facts, many people disagree. The primary reason detractors, or supporters of the “debt snowball” method, may argue is that Dave Ramsey’s method will help you pay off your smaller debt faster, providing you with “early success” and possibly the motivation to continue along the path of debt reduction. The Debt Avalanche will also provide early success, but if you need special motivation to continue your monthly payments, consider this: By choosing the Debt Avalanche method, you will pay off your total debt faster, you will pay less interest, and you are mathematically efficient.

That is motivation enough. Or is it?

Dave Ramsey believes his “debt snowball” method, in which debts are paid off in the order of balance from lowest to highest, has shown better results than any other method thanks to “quick wins.” If he were to ask his followers if they want to carry their debt longer and pay more interest throughout before offering the “debt snowball” method, they would choose the faster, cheaper, better option of the Debt Avalanche.

One of the many reasons people can fall into debt is the difficulty of separating emotional thinking from rational thinking. The Debt Avalanche helps separate these two methods of thinking, as the best financial decisions are almost always the rational decisions. But it helps to pay attention to some of the psychology involved, as well.

The possible motivation due to the “early success” aspect of the debt snowball method is cited by many followers to be its strongest point, encouraging debt reducers to continue down the path. Followers of the mathematically and financially superior Debt Avalanche, if they need this sort of motivation, can achieve the same effect by defining milestones.

Rather than “celebrating” when your first full credit card or other debt account is paid off, take note and reward yourself when you’ve paid off your first $1,000 (or $500 or $10,000, whatever is applicable to you). Setting and achieving these short term goals influences the same area of the brain (the mesolimbic system) as the act of paying off the first credit card and are similar enough to provide the same motivational results.

Quick wins may help to motivate debt reducers to continue along the path, but the real win comes in knowing you’ve made the smarter choice.

Photo: Ai@ce

Updated November 25, 2013 and originally published July 7, 2008. If you enjoyed this article, subscribe to the RSS feed or receive daily emails. Follow @ConsumerismComm on Twitter and visit our Facebook page for more updates.

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About the author

Luke Landes, also known as Flexo, is the founder of Consumerism Commentary. He has been blogging and writing for the internet since 1995 and has been building online communities since 1991. Find out more about him and follow Luke Landes on Twitter. View all articles by .

{ 166 comments… read them below or add one }

avatar Twiggers

I used this avalanche method and have paid off $36000 in less than 6 months. Still have $29000 to go! I call my rollover amount each month my snowball, but it really is an avalanche!

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avatar ELSY

Hello my name is Elsy.

I think you can answer some of my questions on how you paid off $36000 dollars.

Please email me. I am having a hard time doing this and maybe you can help me.

Thank you in advance.

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avatar Jose

I am in the military and going through a divorce. I have been in and out of Iraq for the last few years. I thought she was paying everything but she was not. I have the money to pay some of my debt in full. Is that the best way to do so or what is the best way to do this? I just want my credit to go up that is all.

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avatar Ralph

I empathize your situation;seeing that this is your debt,and you have the money to pay them off,that’s your best choice. I suggest that you talk to a non profit credit counselor as well,there are many available,and they can give the best options,and set up affordable payment plans.Good luck.

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avatar Jose

First of all, thanks for your service. Secondly, with all due respect, your financial problem was avoidable; however, the divorce not so much and it is unfortunate. Third, in my opinion, you should invest time in reading and learning about the various methods for paying off debt and develop your financial language. Then decide, based on your goal (higher credit score), choose the plan that is the best for you. If you have already paid some of your debt in full, it’s not to late to learn. The library would be good place to start. I would recommend starting with “Increasing your Financial IQ” by Robert Kiyosaki. Then read “Rich Dad’s Guide to Investing”, also by Robert Kiyosaki. I’m reading this now and it’s changed my perspective on what I want out of life. I hope this message finds you well. Trust me, you don’t end up with 38K in debt and 37 years old. I just now discovered why 97 out of 100 people in the middle class never get out of or perpetually live in debt and in many cases survive paycheck to paycheck. Or even worse, when there older find themselves out of money and poor. So listen, if you’re not looking beyond this debt Jose, that’s unfortunate, but if you are, that’s great. And if you have a financial plan, you’re ahead of the rat race, if not, that’s your choice and I have no sympathy for you.

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avatar Larry

Jose,if you decide to pay these in full, I hope you sue the hell out of her !!!

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avatar Kate

I agree. I would always choose the avalanche over the snowball, for the very reasons you point out. The reasons provided in support of the snowball always struck me as quite odd.

But then I realized that they do make sense for people with a certain mindset. Not to be offensive, but that mindset is not a logical, orderly, or deliberative mindset. The snowball probably works well for people who are deeply in debt from out of control spending and lack of financial discipline.

So for those people who are going to backslide and return to an undisciplined approach to money unless they see the concrete result of paying off one debt in full very soon, I suppose that’s a great approach. I see it as a proof of concept situation for people who aren’t yet able to look at their finances from a strictly logical and efficient perspective yet. Better that (less efficient) method of debt reduction than no method at all, right?

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avatar Dude!

OK , you people have too much time on your hands. Some people are just wire differently. I say do what works for you. There’s just as many logical people in debt as anyone else. Just because you can read a spread sheet. Doesn’t change the fact that debt issue come to all types of people. Emotion is always going to be a factor, in what we buy and how we buy it. Some make a ton of money, some don’t. I know a dentist who makes a ton of money, and he’s as broke as my garbage man. He has expensive toys, but it’s paycheck to paycheck baby…. If you have extra money, work on paying off a bill period. And stop using the cards… If the non logical way works for you than do it that way. If you were so logical, you wouldn’t have the debt in the first place, right? Stop thinking about it and just get started. What ‘s the other option, keep doing what your doing now? Any method is better than that. Don’t give me That “I’m so logical, and smarter than everyone else” that I’m going to slam how you do it…Like Nike says “Just do It”

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avatar Ronald R. Dodge, Jr.

whoa whoa,

While you definitely have some valid points dealing with human behavior, don’t peg us logical people as our logical way of thinking means we don’t ever take on debt. I’ll admit I am very logical with how I look at things. In my case, the area that I definitely got majorly hurt with was having to take on student loans, only to not have any of my credits transfer over and end up taking on even more student loans while only having $4,000 annual income for a period of 6 years in the 1990′s. Even to this day, I am still indirectly paying for this very situation, though I am definitely making headway to get out of that situation. On the other hand, I also realize what happened in the past is in the past, the situation is what it is, and I have to deal with it.

In addition to me having to pay for my own student loans still given the very low income in the 1990′s, I’m also having to pay on my wife’s student loans given the fact she isn’t working. Not only that, but with her, while my situation was due to lack of sufficient income while basically living on my own with the only help I got was a relative paying for my rent, but everything else, I had to pay for myself, my wife had a lot more help from her relatives and she was very careless with the credit cards. It wasn’t until during the 2000′s when she started to learn about what it meant to be responsible with the credit cards as I monitored her usage quite heavily and would take it away from her if she didn’t follow through with the responsible means. But even with what I had done through the 2000′s, it only got me so far, and it was via the Financial Peace University course done at the church when she finally realized what I was doing financially was the real stuff, not just something made up in my mind. While I don’t agree with some of the methods in the course as it’s too risk adversed, it doesn’t take into account of available technology today to make things much easier, and it’s numbers are way outdated, it did serve the purpose as to why I had her take the course (which I took it with her but more so as support for her among other reasons to help her out). What made it so real for her was the various experiences the course brought out which we also went through such experiences. It was only then she finally accepted the financial stuff that I had been doing all along. Once she accepted that, it was then and only then that I could really made any real headway as it requires team work on both spouses and sometimes even with the kids though not in the same manner.

Another example of logical people taking on debt that I did. Renting vs Mortgage on a house

While I understand some things where Dave Ramsey is coming from, I personally don’t agree with his method. As a matter of fact, I hated being a tenant cause I had to deal with slumlords much of my time renting. They would not maintain the buildings to the point the utility bills would go sky high (older windows, cracks in the foundation) and then attempt to pin such things onto the tenants as if it’s the tenants fault. Not only that, but the so called maintenance person would come over, but yet, they would open the windows wide up in the middle of the winter months when it’s below freezing letting all the heat out while you are away from home at work or school, and you are the one stuck with the high heat bill cause of that.

Therefore, when it came to renting vs owning, it ultimately came down to 2 basic questions?

First, what’s the total cost of renting vs what’s the total cost of owning a home including the mortgage. If the owning of a home is the lower of the 2, you still have to ask yourself one other question.

Second, once you have that mortgage, what are the risks of not being able to keep up with the mortgage and what steps can you take to minimize that risk.

As such, in 2005, I jumped shipped when I could with being a tenant as I hated being a tenant and become a home owner. Yes, that meant I took on another debt, but I did so knowing the risks and I have taken steps to lower such risks. Hence, even though I’m very logical, but yet, I did take on another debt. Even to this day, I am every so glad I jumped shipped even though that mortgage was originally set to mature in July 2035. Now it’s set to mature in August 2032. This year, I will continue on paying it down until I get rid of the MIP entirely before reverting back to ramping up my EF all that much more.

The only reason why I would revert to the principle route (and only on a temporary basis) is if I really did need to decrease cash flow demands and I had no other way to do it realistically and I couldn’t increase cash in flow realistically either than what has already been increased. Otherwise, I will stick to my equity method of finances as I will bypass Dave Ramsey’s cash flow method of finances.

Example: Do I pay down the student loan (3.75% stated APR with a tax deduction before AGI that compounds monthly under the daily simple interest rules) that has a $6,000 balance, or do I pay down the mortgage (4.99% stated APR that is not tax deductible other than via the Schedule A which I have never come close to being able to use, even in my first full year of home ownership, which the interest rule is a hybrid of rule of 7/8 and simple interest) that has a $101,000 principle amount still on it. It is like the rule of 7/8 as it doesn’t go by the exact date the payment was made like student loans go by with it’s simple interest rule, but it’s also like the simple interest rule cause when you do put extra amount of money on that monthly payment (Provided the bank doesn’t play games with it such as put the extra amount into the escrow account), that does reduce your absolute interest charge while the rule of 7/8 would not reduce your absolute interest charge even if you applied extra amount. The only way to reduce your interest charge with a purely rule of 7/8 loan is to pay that loan off in full. That’s cause with a pure rule of 7/8 loan, once the loan is established, the interest charges are all set based on it’s original payment tables. Even if you make extra payments or more on that same payment, they will still charge you as if you stuck to the original payment plan thus not taking into account the extra payments made.

According to Dave Ramsey, he would say get rid of the student loan first cause it’s a lower principle amount. I have several issues with this route.

First, the student loan has a tax benefit which means it’s effective percentage rate is actually lower vs the mortgage has NO tax benefit to me.

Second, the mortgage has a MIP on it that essentially raises the stated APR on it from 4.99% to 5.49% before taking into account of the compounding interest factor. (BTW, the MIP is the government version of the private sector PMI)

Third, the mortgage has a rule of 7/8 factor to it, so not only do I need to pay it down via the rate method and also in regards to getting rid of the MIP, but cause of this rule of 7/8 factor, it’s not like I can just apply extra payments to it like I can with student loans, but rather I must plan accordingly as to how much extra I will apply to the regular monthly payments, so as they don’t just treat these payments as extra payments to future payments as they would otherwise if I just made extra payments (Yes, that’s one of the problems with mortgages as to why I say it’s still a rule of 7/8 factor).

Fourth, the so called accellerated bi-weekly payment plans, I will never get into them as they have a $250 up front charge to them and a $4.00 per payment transaction fees, both of which I can totally avoid by using my cash flow management worksheet and plan as to how much extra goes onto such regular monthly mortgage payments. As such, I will still come out way further ahead just by applying the extra money to the monthly payments than to go with this accellerated bi-weekly payment plan.

Now if I was in the boat that I had to really free up cash flow, then yes, I would go to the route of paying off the student loans. However, I am not in that boat. I have enough reserves to currently cover me a minimal of 15 weeks. That’s still very little considering that doesn’t take into account of long-term assets or other sudden losses, but it’s still probably better than at least 70% of households within the nation.

Anyhow, as to which method people take, you are right, each household must decide which of the 2 ways are better for them, which as far as I’m concerned, it boils down to 2 basic things.

Are you financially disciplined? If not, then principle route would probably do you. These days though, you may be able to use the rate method given how far along technology and how much more are now available these days online, but then that would require you to be computer savvy too.

Do you really need to reduce your cash flow demands given the constraints on your cash in flow? If so, then again, the principle route would suit you on a temporary basis until the answer to this question become a “No”.

If you answered “Yes” to the first question and “No” to the second question, then you would more than likely want to do the Rate method.

The only other thing to keep in mind, and this is something that I had to learn, you must strike a balance as to how much of the extra money to put towards debt reduction vs how much extra money to put into retirement funds (given the IRS annual limitations you can put into such funds and what it takes to make it all work) vs how much extra money you need to put into the emergency funds and/or other investments. For me, I use a set of rules and compare to the circumstances to determine how to split the extra money between these 3 areas of savings. As for Dave Ramsey, he believes in going with one way and sticking to that one way until it’s completed. Me I don’t believe in that cause if you are in that debt reduction mode, and you don’t have enough of the emergency fund, you can find yourself in some major tight holds that can cost you majorly extra, which hurts your long-term objectives. You also can’t just strictly drop all of your debt and up your emergency funding before you start saving for retirement cause you can’t get those years back to put into retirement savings given the IRS annual limitations. As such, you must find a proper balance to all 3 of these means of savings.

Each household may have a different set of circumstances which may cause the split to be different between the 3 categories. However, the one rule I will not veer from, 25% of actual gross earned income must go to countable savings, which these 3 categories are the only areas I allow for countable savings.

Actual Gross Earned Income = Your gross payment on your pay stub plus any matching contributions into your retirement funds by the employer, or in the case of self employed, Net Earnings/(Loss) before income taxes using US GAAP Rules (AKA EBIT).

This year though, given the 2% FICA holiday on the OASDI portion of FICA, I actually jump that 25% up to 27%, which I’m made it a requirement the additional 2% to go into retirement savings.

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avatar walt1948

wow man; like why don’t you just write a book! too long of a reply-keep it short the next time OKAY!

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avatar Ronald R. Dodge, Jr.

As to which method to use, Rate vs Principle:

If you are NOT financially disciplined, then the principle route will probably work better cause it doesn’t require as much tracking in the long-run even though you end up paying more in interest with this method.

If you are strapped for cash flow and need to increase cash flow, which you can’t do much on the income side to increase the availability of cash for other things, then again, principle method is probably the best route until you get to the point you have enough cash availability to cover your needs. Reason why principle may be better with this method, if you end up having to take out more debt, that would most likely mean more up front fees plus more interest charges, and that’s not in your best interest.

Otherwise, if neither of these reasons fit you, then you really do need to go with the rate method as that is logically the better route. Reason being, you will reduce the total amount of interest you pay much faster than you will under the principle route.

Therefore, the real question should be, do you need to decrease your cash flow demands at the cost of additional interest payments, or can you go with the rate route and avoid having to pay for any other additional financial fees should something happen that may very well disrupt this avalanche method.

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avatar Twiggers

You know what though….you forgot one thing that happened to me. Your minimum payments on the remaining cards WILL go down slowly every single month. So you do need to tweak the monthly avalanche to take that into account. It might not seem like a lot, but it can quickly add up to an extra $25-50/month that could go to the avalanche.

Also, I am not rolling my mortgage or student loans or car into this. I guess I see the mortgage and car loan as a secured loan….so I’d rather pay off the unsecured debts first and then worry about the rest. It could also be because the interest rates on those are typically lower than a credit card anyways.

Also, one final thing. I would recommend that people doing this actively look for 0% balance transfer cards. This will ONLY work if you can chop up the remaining cards and be strong-willed. I just consolidated $20K of my credit card debt on a 0% interest card and am saving about $200/month in interest alone.

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avatar Lumberg

Hope the 0% doesn’t end before you’ve paid the balance in full. Otherwise, you’ll get a nice finance charge at the end of promo rate. Then the remaining balance’s APR will end up going up too.

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avatar Ronald R. Dodge, Jr.

Lumberg is right about that as for your $20k is concerned.

I’m also with you on getting rid of such debt first, but more so on account of the interest rate aspects, not the type of debts.

As for me, I do use the CCs, but only in accordance to my cash flow budget plan. The only exception I have to that, I may end up using the CC for such items that fall into the category of financial emergencies even though they aren’t really necessarily true emergencies (such as car repairs). For such items, I will first use the CC, but then if need be, I will pull out such funds from the emergency fund.

The emergency fund is no where near funded to the point I technically need to have it at, but that’s just one reason why I have had to setup financial rules as to determine how to split my extra money between debt reduction, additions to the emergency fund and contributions into retirement funds. It’s not something that’s an easy thing to come to a striking balance between the 3 saving routes, but it’s something I have had to come up with based on our set of circumstances (both now and in the future), the rules in place (Including matching policies and IRS rules), and how money works.

Other than what I call current debt (those debts that’s paid in full within each billing cycle thus avoiding the finance charges), I have no CC debt, and the only long-term debt I have are student loans and the mortgage. Not just from an absolute stand point of view, but also from the stand point of view of total cost per borrowed dollar, the mortgage is more costly than any of the student loans. As such, for debt reduction purposes, unlike Dave Ramsey requirement, I have the mortgage on the chopping blocks. One such reason, the mortgage has NO tax benefit to me with a higher stated APR than any of the student loans, which the interest on the student loans is a tax deduction before AGI. As such, I am there at that point of which way to go with the extra money.

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avatar Jac

“That is motivation enough.”

Well, clearly it’s not, or this would work for everyone. Why does it bother you that people choose a non-mathematically optimal route to getting rid of debt? Just be grateful that you are one of the people who find spreadsheets and numbers interesting and motivating, and try and encourage others to work on it whatever way works best for them.

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avatar Ronald R. Dodge, Jr.

You know Jac, you definitely right. When I talk with people, it seems only about 5% of the population really use spreadsheets to help themselves, and even out of that group, very few people even seem to use it to the extent like I have to go to the full extent with finances. I know where I work at, out of the several people that had worked there (prior to the 74% of the work forced laid off), I was the only person who was using US GAAP rules with the household finances. Of course, I didn’t strictly follow US GAAP rules as there’s a couple of places where I differed from US GAAP rules, but that’s was more so from the stand point of view of reducing the pre-tax items to conservative after-tax numbers so as to be able to compare oranges to oranges rather than apples to oranges. But even with that said, my networth numbers are still the same as they would be under strict US GAAP rules. That’s cause it doesn’t matter if the income taxes related to the pre-tax investments are reported as a contra account to the investment accounts on the balance sheet or if they are reported as a liability on the balance sheet. The only place where such numbers are changed would be in the ratios such as assets to liabilities, but those ratio numbers don’t have as much meaning to me as comparing all after tax numbers to each other does to me. As far as I’m concerned, you can’t compare a before-tax investment number to an after tax liability or after tax long-term asset number, cause of the tax difference would skew it.

Very few people though go to such an extent as I go with this financial stuff. But then again, I have a very unique position in that I am very good with numbers, I am about as advanced of a computer user as one could be (95% of the computer stuff self taught as the stuff they teach in classes barely even scratch the surface), and I have that Accounting education background to formalize the financial stuff (what they teach in the first 3 years of college for Accounting, I learned in high school at Genesee Area Skill Center in Flint, MI as part of my 25 annual credit hours of high school. Yes, that’s one more annual credit hour than what most high school students graduate with).

The one thing many people find hard to deal with, they can’t seem to relate to abstract levels. For me, I can switch to various abstract levels like nothing. However, to do that, this is not just something one is just granted. It’s a skill that has to be learned, which for me, I ended up learning this skill pretty early in life as it’s one such thing that had more or less opened the doors of knowledge to me. Most people have to be able to see it in order to learn it, and thinking in different abstract levels requires being able to visualize things without actually see it, which again, most people can’t seem to do.

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avatar Luke Landes ♦127,372 (Platinum)

Jac: I wouldn’t say that it bothers me, everyone is free to pay down debt as they wish. Those who promote the “debt snowball” method don’t explain that this method keeps an individual in debt longer and and is more expensive. Spreadsheets are the same tools whether used for the “debt snowball” method or the “debt avalanche” method.

If someone wants to use the “debt snowball” method, it doesn’t bother me one bit, as long as they understand that it is neither the fastest nor the cheapest way to use their available funds to get out of debt.

Twigger: Good point about your minimum payments — they do change as you pay down your debt so you’ll have to be mindful of how much you’re sending to each debt account each month. Congrats on your progress!

Kate: the undisciplined approach does not lend itself to paying off debt. If you’re serious about paying off debt, I believe it should be done efficiently. A slight change from the popular “debt snowball” method can make a big difference.

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avatar Ronald R. Dodge, Jr.

Flexo, in many respects, I agree with your statements here. However, here’s a couple of things to think about:

To be quite frank, most people don’t even track their financial stuff as they don’t want to have to be thinking about their financial stuff every waking moment or every single day. Personally, I really don’t want to either, but I also learned ahead of time, I had to do it pretty much daily until the more recent online tools finally done away with the fees, which then made it much more easier to do the rate method without having to think about it every single day.

With the Rate method, you are probably making a larger number of payments than you do with the principle payment in the long run, which means such people have to be that much more disciplined of tracking all of their debt that much more.

You are absolutely right, with the Rate method, you are paying in less dollars in the long run than you are under the Principle method. I’m with you, you should be as efficiently as you can be with your money, but if it was up to my wife, this would be a disaster waiting to happen, so in her case, the principle method would work better. However, since I’m the one in the driver seat with our finances, we are using the rate method.

However, one thing that I do argue as to why the principle method is no longer really a valid route even for the “UNDISCIPLINED” or “FREE SPIRITED” as Dave Ramsey call such people, there are now tools available online free of charge to schedule such payments in advance of time and with the help of spreadsheets to use for cash flow management, even the undisciplined can now days use the Rate method and not have to think about it every single day. If you go back 10 years, this would not have been realistically posible cause there was no such thing as scheduling such payments in advanced without having to pay maintenance fees for such online banking. Hecks, for that matter, 20 years ago, this wasn’t even in place at all as things were all still ran by the very slow 4KB/sec dial ups for internet service. Now days, we connect to the internet at speeds that’s more like 1GB/sec (which is 256 times faster than dial up).

But even with this said, given you still have the spreadsheet component to this for cash flow management, the undisciplined may still fall to the principle route instead cause they aren’t disciplined enough to do things by spreadsheets or even on paper (hence why so many people live from paycheck to paycheck).

Speaking of living from paycheck to paycheck, in some ways we do, but in some ways we don’t. In the sense we don’t, I do have an emergency fund and other items in place, so if something does happen, we do have some coverage. On the other hand, in the sense we do live from paycheck to paycheck, we can’t go for very long without one of us working full time. We still need that income to take care of various things including building up our retirement funds. For us, we have total investable assets on an after tax basis as being only 1.2 times of annual wages and I want that to be a multiple of 50 before retirement. So in that regards, we are well behind goal, but I’m making due what I can.

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avatar Ryan

If you were to walk up to someone who was thousands of dollars into credit card debt and tell them to do something because it was “mathematically smart,” you tell me just how motivational you think you’d be. ;)

What I mean to say is: people get into these positions because, to them, math doesn’t motivate, having something in their hands that they can see, that motivates.

For these, Dave Ramsey is right on. Ramsey takes into account a “mindset shift” that has to take place. You don’t simply say, “This is better because it’s mathematically smart–let me get out my spreadsheet and show you.”

First things first: people have to experience themselves impacting their own circumstances.

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avatar Luke Landes ♦127,372 (Platinum)

Ryan: People don’t get into debt because they don’t understand math, but because they are not exposed to the consequences of their spending. Dave Ramsey argues that having a small success (paying off your smallest debt first) quicker will motivate a former debtor to continue along the path, but if you tell that person that their small success is costing $x and adding y months to their total payback period, then it’s hard to imagine anyone not feeling hoodwinked for following an inferior debt reduction method.

With the debt avalanche method, your first “small success” (defined by paying off a debt account fully) could take place at the same time as it would with the debt snowball method, if your smallest debt also has the highest interest rate. So it’s possible that the first small request would come as soon as it would otherwise, rendering the “benefit” of the snowball method irrelevant. But in the chance that it doesn’t, redefine the first “small success” to be a certain dollar amount, say $1,000 total paid off across all accounts. A milestone like that can be a motivational factor as well as anything defined by the snowball method.

I understand from personal experience how different things motivation different people and things like this should be tailored to the individual’s needs. If it is *explained in plain language* to those wishing to pay off debt that it is more expensive and longer to use the debt snowball method, there is only one obvious answer. Then, if motivation is an issue, and if the time before the first full debt repayment is drastically altered by the method chosen, redefine your small successes to be milestones. This can be designed in such a way to be motivational to those same people who were motivated by the first full debt repayment.

People are smarter than we give them credit for, even if they’ve found themselves in debt. Professing the debt snowball method is like a teacher instructing the entire 25-student class based on the needs of the one student within the class who is the least able and most reliant on hand-holding to perform a task.

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avatar Ronald R. Dodge, Jr.

You right with some aspects such as using milestones, which I also use milestones. However, one thing to think about, a lot of people can’t even seem to think in abstract levels and the milestones requires people to think in abstract levels.

As for giving people credit for how much knowledge they have, I have experienced just the opposite of even many of my co-workers. Quite sad if I may say, but there’s 2 basic things I found very profound and that was rather disturbing to me. First one was why can’t people seem to do even just the basic 4 math operations. There were many times I had set some things up and they were like they can’t even do the basic 4 math operations. It wasn’t like I was asking them to do some sort of statistical problem. Second thing, with the various computer programs I have done for the production floor, you wouldn’t believe I had to take such programs to make it as idiot proof as one could possibly take it to. True, some of them would be able to handle it pretty well, but others, they couldn’t and as such, I had to take it to such a level as to make it basically a mouse usage only except for a few places where it had to be keyboard usage for data entry. I had to setup such programs cause the programs the IT department was wanting such people to use were text based only and expected them to go to all sorts of places. I saw too many issues and pointed them all out (some dealing with too much effort required, some dealing with security type issues, and some dealing with for those that are rather computer savvy may also look for ways to fudge the numbers), so all of those reasons, I had to create my own program and then get that data updated into the main data base. The people in the IT department said, it would only require training, but they had no idea what sort of people we had to deal with.

As such, you wouldn’t believe how ignorant some of them people were, but in other cases, it was a situation where many of them didn’t give a care and wouldn’t even follow through unless their job really depended on it meaning if they didn’t follow through, they would lose their employment, which for the longest time, they didn’t. However, came this lay off time period, many of such people did lose their jobs. To be quite frank, it’s rather frustrating to have to deal with such people.

Don’t get me wrong, there are those that takes some time to learn, but as long as they are giving their honest best effort and are at least gradually picking up on it, then I’m okay with it. But if they aren’t at least doing that, then that’s when it’s very frustrating.

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avatar Tom

Flexo, I read your article and to a certain extent, it makes sense, but like some on here, it depends on your circumstance. If you were to ask any average person with average financial understanding if they want to pay off 2 credit card bills with approximately $2,000 on each or wait on that and try to tackle a $10,000 credit card bill, which may take months, I’m not a betting man, but I would say they would want to pay off the 2 credit card bills of $2,000 each. I’ve been doing the debt snowball that Dave Ramsey advocates and I paid off $20,000 by using that. It’s good to see that each month I’m paying off one credit card bill after another. If I used the Avalanche approach, I would have paid off maybe 2-3. It all depends on what motivates you; seeing a credit card bill paid, or month after month, still seeing the higher balance credit card bill; albeit, getting smaller. Good advice on your part though!

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avatar KC

The debt avalanche makes perfect sense for those who can handle it. But the debt snowball is still probably best for most people. They got into credit trouble from spending. They need instant results. That’s why they need to pay the smallest first – to get faster results and gratification. Ramsey promotes this cause he knows the average person can’t do the more reasonable, sensible thing – which is what you are proposing.

One time my husband and I were listening to Dave Ramsey. He said, “Who is this guy? He’s such a d-bag to his listeners.” I told him who he was and that the reason he is so harsh is because his listeners are desperate and need to hear this in the maner he delievers or else it won’t hit home with them. That’s who guys like Ramsey are geared towards – those who are desperate, and need a quick approach, which may not always be the smartest.

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avatar Chris

I agree mathmatically your method works, but not EMOTIONALLY for many people. That is why the debt snowball works for many.

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avatar Luke Landes ♦127,372 (Platinum)

Chris: I agree that the debt snowball method “works,” it just doesn’t work as well as the debt avalanche. I’ve already explained how to design motivation into the debt avalanche to make it work “emotionally” as well, but let’s face it… we should do our best to eliminate emotions from financial decisions of all kinds, not only debt repayment but investing decisions, etc. And to assume that people can’t do this doesn’t respect the intelligence of our fellow human beings.

As I mentioned, the “emotional” response to a quick success can also be achieved with the debt avalanche method by redefining milestones. But if your debt reducer can’t see the big picture and choose the faster, cheaper, better option of the debt avalanche method, then they haven’t learned to separate money from emotions or to make intelligent decisions about their finances… and thus, they have a higher chance of ending up in debt again.

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avatar Luke Landes ♦127,372 (Platinum)

KC: I would hope that those who call into DR’s show understand what is in store for them in terms of attitude. Dave Ramsey’s show is about entertainment, after all, and of course, syndication. I’m sure DR has helped people get on the truer path to financial independence… but let’s help them more by saving them money and time when paying off their debt. By the way, by the time someone decides to listen to Dave Ramsey, they’ve already decided that they need to pay off debt, but they’re looking to learn how.

That’s why the debt snowball method is so popular — it “answers” the exact question that listeners have when they finally decide to tune in and change their life. Unfortunately, it’s not the best answer.

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avatar Twiggers

I guess it really depends on the situation you are in. Financially it is always better to do the avalanche method, but psychologically, Ramsey’s method is better. When I first started I wanted instant results and decided to settle in the middle. I picked a card with an average balance and a middle of the road interest rate. Paid it off within a couple weeks and got some satisfaction. Then decided I was being stupid and wasting money and starting tackling the higher interest cards (by high interest we’re talking less than 10%). I personally think you can combine both and still get the motivational results and save money on the finance charges.

here is another catch that people just won’t do. You NEED to change your lifestyle. Whatever lifestyle you were sustaining got you into this horrid mess. If you don’t let go of the lifestyle then no snowball or avalanche will change things. You need to cut back expenses, and somehow make more money in order to get out of debt! That is just plain common sense.

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avatar Patrick

I’m not sure about Dave Ramsey, but every blog or article I’ve seen explaining the debt snowball has pointed out that it isn’t as efficient but works for many people. I can’t believe people *don’t* realize that.

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avatar Ronald R. Dodge, Jr.

With the kind of people I had to deal with at work, I most certainly can believe it as it seems 90% of the people really don’t give a care.

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avatar Benjamin

The trick is finding whatever works for you! I found wiping out the smaller debts first just to clear them out was best! But in the end it may of only cost me $20 in interest over the year and a half that it took my family to pay off over $97,000 in consumer debt.

I love the name “Debt Avalanche”. This applies very well to my brother-in-law when my wife and I helped him snowball his debts. He actually had a Chevy Avalanche that was a large portion of his debt. Once we dropped that baby it was only a couple more months before we had him on “easy street”.

regards,

ben

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avatar Pete

I agree that your way is more financially sound, but I don’t think Dave Ramsey ever says that his way is the best way to do things mathematically. In fact we’re taking a Ramsey class right now, and in the video discussing the debt snowball he says outright that the debt snowball isn’t the best way to do things mathematically.

What he does say though is that it works better in action because a lot of people who have gotten into debt aren’t there because they’re good at math. They’re there because they’ve made lousy financial decisions and life choices (in most cases – i realize some people are there because of medical emergencies, etc). They’ve spent money emotionally, and haven’t made wise choices. Chances are unless you give them a method that takes into account the emotional side of spending, they aren’t going to succeed.

Having the small boosts from paying off smaller debts gives the momentum that a lot of those people need to continue down the path of paying off their debt. If instead they’re paying off the higher interest, and possibly higher balance debt – it takes longer, and the results don’t come as quickly. When they don’t see the results often they give up on making the payments because it doesn’t feel like they’re making headway.

Personally we’re out of debt so thankfully we don’t have to deal with this. I think if I did have debt I would probably do things your way – but that’s because I’m more into numbers and keeping track of our finances. For most others – I think Ramsey’s method will probably work better.

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avatar Ronald R. Dodge, Jr.

I took the course this time last year with my wife (I required my wife to take it so as she would realize what I was doing with our finances was the real deal, not just something that was made up in my mind, which it worked for that purpose), and he outright denied it saying the reason for it was human behavior as to why it’s best to go with the principle route. I’m sorry to say, but I’m not driven by the number of debts dropped but rather by the moving up of that bottom number (networth value). To be quite honest about his course, I have 3 major criticisms:

First, the numbers are outdated such as that 15% saving rate for retirement, I did the self study on retirement and found that percentage needs to eventually go up to 25%. That 15% is based on the old outdated limitation you could put into a Traditional IRA or other retirement saving accounts like the 401(k), which now days, there is no percentage limitation as to how much you can put into an IRA. Now days, you have just the absolute dollar amount instead. The only exception to this would be like the SIMPLE IRA dealing with self employement and/or small business retirement saving vehicle.

Second, his debt snowball method only works for those that are by his terms, “Free Spirited” or what I call “Undisciplined”. I am disciplined and I won’t use the principle route unless I had to reduce cash flow demands, which then I may switch to the principle route on a temporary basis until the cash flow is back in sync.

Third, his stuff doesn’t take into account of current technology as he strictly believe on doing all of this financial stuff on paper. Even the tool he has on his web site, it’s so cumbersome to do online, it requires even more work than what it would require to do on paper. I can do the work so much faster within Excel (and I have) than what I could possibly do with his tool. Not only that, but for the level I go to with our financial stuff, if I was to do it on paper, it would take up so much freaking time, I couldn’t stand it. That’s why in July 2001, I had to switch everything over from paper to Excel as the stuff got to be too complex to do on paper anymore. For the most part, for any one week, it only take generally 1 hour, but could be up to 2 hours. The only exceptions would be the quarterly reviews could be a 1 day process and the annual budget process could take up to 2 weeks though the last time we did it which was in the month of August, it only took me 3 weeks to do as I got the process down so well, it doesn’t take nearly as much time to do as it use to take before hand.

As such, I found his process to be too risk adverse with his cash flow method to financial independence vs my equity method to financial independence. This may be true for the undisciplined, but when I compared his method to the self study I did on retirement including the risk factors both during retirement as well as during employment years, I found his cash flow method much more likely to fall short of financial independence than my equity method for those that are disciplined.

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avatar Andrea Smith

When suffering from a large debt, consider your alternatives, negotiate with your creditors and know the next steps in consolidating your credit. Thanks for the article!

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avatar Julie

I just have issue with referring to the Avalanche method as the “correct” one. The correct one is the one that WORKS.

It reminds me of weight loss – the most successful programs emphasize incremental changes and intermediate goals. When a person has 100 pounds to lose, it’s easier to focus on the first five instead of the next 95.

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avatar Ronald R. Dodge, Jr.

You absolutely right Julie. I’m with you as each household has to find what works best for them, and how determined are they. It’s just like with me, for many things, I can only make small incremental changes at a time. However for those items that I am very determined, I could and have made the huge changes, but that is more of a rarity to happen than it is the norm.

As for the financial stuff, can you easily track the various debts, or do you have to do it one by one. For me, I can track them all without any problems, so the rate method is obviously the one that works best as long as the cash flow isn’t an issue, which it hasn’t been for the most part. But for many, most people can only work with one debt at a time, and they also can’t think in abstract levels too easily, so the principle method seem to work best for them.

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avatar Luke Landes ♦127,372 (Platinum)

Dave Ramsey’s plan “works,” but it is not the best choice. Both methods can emphasize incremental changes and intermediate goals. The “debt avalanche” is cheaper and faster. Anyone who makes the “debt snowball” method work can make the “debt avalanche” work by looking at the milestones in a different way.

At first I believed the “debt avalanche” method was the best way to go. Then I realized that people who follow Dave Ramsey’s suggestion may have a point. Later, I came to the conclusion that the positive aspects of Dave Ramsey’s plan can be applied to the “debt avalanche” by looking at the milestones slightly differently as I’ve mentioned above. Not only that, but the “debt avalanche” method emphasizes separating emotional thinking from rational thinking, which is a good thing for those who have a habit of finding themselves in debt.

When dealing with money, the best option is to put your emotions and ego to the side and accept that the best answers are always the mathematical answers. And yes, this is coming from someone who understands quite a bit about psychology. Not everyone is motivated the same way, but various motivation techniques — the same ones that work for the “debt snowball” method — can be applied to the “debt avalanche.”

So if you’re serious about reducing your debt, there is no reason NOT to take care of it the most efficient way possible. You can be successful with either method, but if you want to save money and time, and if you want to prove to yourself that you can make intelligent decisions about money, do it the right way, the way in which you’ll pay less interest and finish faster.

There is a time and place for the psychological aspects of money management, but this isn’t it, just like it’s a bad idea to buy or sell stock based on your emotions.

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avatar Ronald R. Dodge, Jr.

You still not thinking about the fact with the rate method, you still may have to think about your financial stuff on a daily basis not to mention you have to track multiple debts for a longer time period in most cases (Cause those debts won’t mature until a later time until you come down to just your mortgage, which then will mature at a much sooner date than it would have with the principle method) For many people they have a hard enough time dealing with working with just one debt let alone multiple debts like that.

To overcome that issue, having to think about your finances every single day with the rate method, one can use the online banking and prescheduling their payments at set times, but then that would also require them to use cash flow management worksheets (note the paper version Dave have them use would have to be redone each and every time it changes to get back to a 0 budget, vs if done in a spreadsheet program, it would be very easy to change it and get it back to a 0 budget much faster and with much less effort). It would also mean one would have to be computer savvy, and to be quite frank, based on my experiences, a lot of them are NOT computer savvy and very few people even know how to work with formulas within the spreadsheet program. As such, I still highly doubt the rate method would work.

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avatar Patrick

You sound like telling the alcholic that the best way to get better is to never take a drink again. While you are right, human’s don’t operate like robots. Everyone of us reacts to situations in different ways.

It isn’t always so easy for a credit addict to do as you ask though “snowballing” gives them the instant gratification that got them into trouble in the first place. It’s taking the flaw and making it work for them. As someone already said, whatever works to help you get straight.

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avatar Patrick

Or even better. It would be better mathematically for a smoker to go cold turkey and not buy the $30 drug prescription a month. However, it’s easier for them to kick the habit and be more likely to not start back up.

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avatar lulugal11

According to my understanding of the debt snowball you can choose EITHER the highest interest first or the smallest balance. I use the snowball term but pay the highest interest debt first.

It is not what you call it that matters…what is important is that you are making an effort to reduce debt.

With both methods you are paying the minimum on all debts EXCEPT one which is targeted to receive a higher than the minimum payment. When I was first learning about debt snowballs I was told this was the basis of dealing with debt…..the choice comes when you decide if to tackle the highest interest first or the lowest balance first.

Different things work for different people and according to my financial situation I have switched from one method to the next. Sounds like you are just calling the same thing a different name here. Same principle.

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avatar Juggler314

If you want to be technical about it being the most mathematically efficient way to pay off debt you should really be factoring in your state and federal tax brackets as well with respect to debts that have tax efficiencies. For instance, lets say you have a “bad” mortgage at 8.5%, and many other debts at 8%. If you are saving 20% of every dollar paid in mortgage interest – that could easily make the mortgage the “worse” debt to pay off even though it’s at the topy of the list interest rate-wise. As you pay that mortgage down, you’ll have less and less cash available to you as a result of your declining tax deduction.

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avatar Ronald R. Dodge, Jr.

I’m with you. I have ordered all of my debt based on just what you said. Here’s what you do:

You start with the stated APR

You then convert it to what most people call “Effective APR” or what I call “Before Tax Basis Effective APR”

You then take into consideration of your marginal tax rate for both federal and state levels, and if you end up having to get a refund, you also have to account for time value of that delayed time to get your refund, which means you have to drop the savings by a smaller amount. Let’s face it, if you got the instant saving and was able to use that money right away for something else, it’s worth a lot more as you can either earn more interest or save on additional interest charges (let’s say July of the current tax year for instance). But if you in the boat like I am with regards to claiming “EXEMPT”, but you don’t get that benefit of that reduced taxes (Or increased refundable credit in this case) until February of next year, that means you have to wait out those 7 months which means you don’t get as much of a benefit from it. Yes, I claim “EXEMPT” on the Federal W-4 form every single year prior to February 15th deadline, but yet, I get like a $4,500 to $5,000 refund from the federal IRS via the Additional Child Tax Credit and Make Work Pay Credit.

As such, while initially, we might say that stated APR of 3.75% is then 3.815% BTBEAPR

That 3.815% would become ATBEAPR of 3.048%, but because I don’t see the real benefit until February after the tax year, it’s really only worth about 40% of the difference, which means it’s really an ATBEAPR of 3.508%

So you see, I not only take into account of the marginal tax rate, but relative to our tax situation, I also had to take into account the time value of money as well.

ATBEAPR = After Tax Basis Effective Annual Percentage Rate

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avatar Jesse

I love these lively discussions. Flexo, I think you should update your post and discuss the redefining of milestones because your comments have outlined it, but your original post didn’t. You have a great point there.

The key to debt reduction–under any name—is intensity.

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avatar Luke Landes ♦127,372 (Platinum)

Juggler314: I touched upon the tax issue in the post — to compare interest rates correctly, you have to factor in all tax aspects to find your effective after-tax rate for each account. It’s a great point and often overlooked. Thanks for providing that example.

Jesse: Thanks! I’ve updated the article to include thoughts about milestones.

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avatar juggler314

ah I missed that little bit about “same tax liability”. Usually all your debts have the same tax liability (for most mortals anyway) except mortgages though…so it’s a pretty big asterisk for the mortgage debts.

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avatar Ronald R. Dodge, Jr.

Hrmmm, for me, the mortgage has no tax benefits, but yet, the student loans do have tax benefits as the interest on the student loans are tax deductible before AGI.

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avatar Luke Landes ♦127,372 (Platinum)

Juggler314: The other consideration is student loans. Some people may qualify for a tax credit based on student loan interest paid.

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avatar Ronald R. Dodge, Jr.

Actually, interest on student loans is not a tax credit, but a tax deduction before AGI.

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avatar dustintweir

Flexo, I have to say that your argument is somewhat passe.

“We are more concerned with modifying behavior than correct mathematics…. I have learned that the math does need to work, but sometimes motivation is more important than math. This is one of those times.” -Dave Ramsey

Your argument is presented, but your readers shouldn’t accept that “if your debt reducer can’t see the big picture and choose the faster, cheaper, better option of the debt avalanche method, then they haven’t learned to separate money from emotions or to make intelligent decisions about their finances.” Your highest-interest-rate-first method is mathematically superior (and that’s not a consession, it’s a fact made by plenty of bloggers way before you), but an intelligent decision for EVERYONE is managing the individual’s behavior. Some might do best with this method, some might do best with Ramsey’s motivation, some might do best by building up a cash reserve before tackling debt, some might do best by paying off secured debt before unsecured debt. You shouldn’t mislead your readers into thinking they’re retards that will always be in debt if they can’t figure out how to pay the high interest rate down.

One personal example is on a recent trip to Canada I made a dozen or so purchases in a weekend. I managed the exchange rates OK, but the bank charged me a currency conversion fee which made me overdraft my account (and if you tell me I should’ve memorized the fee schedule, I’m going to kick you in the nuts). After this hit, I had a necessary vehicle expense which I couldn’t pay, and had to put it on my credit card. Because I’m not a robot and have a dynamic financial situation, I found it best to build up a small cash reserve in checking at, *GASP!*, 0% interest. Guess what! I don’t pay overdraft fees anymore, and I’ve completely stopped adding any additional credit card debt. At a card interest rate of 10% and an overdraft fee of $35, it’s MATHEMATICALLY better for me to hold $300 for a year as cash at 0% than to put it toward the debt, and I won’t expand my total debt if any unexpected expenses of less than $300 show up.

To your readers: your most intelligent decision is whatever gets you out of debt, period. You’re plenty intelligent if you can simply accomplish that goal, and not try to follow a plan that doesn’t work for you that could theoretically save you $75 a year in interest charges. Take his advice, keep on reading, and do what’s best for you. (you genius, you)

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avatar Ronald R. Dodge, Jr.

Very good point, though I personally do use credit cards, but only to the extent of the cash flow budget and if it really meets within the requirements to be considered for use of the emergency fund as the CC serves as a time gap filler with the EF from the bank account (Provided the funds are in the EF anyhow, which at this point, it better be unless it’s a huge expense, which in that case, it’s not something to be tought about right then and there, but rather for a one week time period minimal). Contrary to your statement about paying interest charges on the CC, I don’t pay it cause I pay it in full every single month by the due date.

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avatar jaushwa

great post. It seems more and more evident to me that the more you separate rational and emotional thinking, the farther you will go in finance. The debt avalanche is the perfect example.

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avatar troy

“mathmatically superior”

I love that.

It is mathmatically superior to pay off higher interest debts first. It is also mathematically superior to not have the debt in the firstplace….or is it. I mean, mathmatically why pay off any debt whose interest rate is lower after taxes than an alternative retun on investment.

What about the opportunity costs of this mathematically superior way. It makes perfect sense with standard stepped debts, but what about odd situations.

Say I have a mortgage at 7% for $500,000, a car loan at 8% for $50,000 and 20 credit cards with an average rate of 5.99% and an average balance of $2,000 each. (don’t laugh, I have seen it)

According to mathematics, I should be paying off the mortgage first. Great. Now I get to pay on 22 separate debts, track them, reconcile them,etc for the next 20 years because it “mathematically” makes the most sense.

Your thesis for”mathematics” fails to consider the most important of issues regarding personal finance. RISK

No one ever give risk enough weight. Not paying off revolving debt cariies risk. juggling several debts carries risk. All debt carries risk. The interest rate is A factor, not THE factor. Balance is A factor. Risk is also a factor. Risk of rate changes, universal default,etc.

The best way to eliminate debt is to pay off the RISKIEST debt first. Sometimes it is the one with the highest payment, sometimes the highest interest rate, sometimes the highest balance.

You must also consider life situations. If you are trying to reduce your debts to qualify for a better rate on your new home purchase, lenders care about your MONTHLY debt obligations,not your TOTAL outstanding debt. Paying off a low interest (5%)car loan with a $700 monthly payment will make a much larger impact than eliminating a 20% $4,000 credit card balance. If that car payoff gets you a .25% better interest rate on a $200,000 mortgage, it is “mathematically superior” to pay attention to your own situation and pay of the loans with RISK.

Rock on!

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avatar Ronald R. Dodge, Jr.

You right in some aspects, but risk is not something that is something that is objective, but rather it is subjective as risks has different meants to different people. Now if you are in a fairly good financial position, then risk factor of your debts are generally lower, but if you are in a in a very poor financial position, then risk factor of your debts are probably quite high depending on your employment situation and your household situation.

Now I agree with you that you can’t just go by mathematical only, but you do have to factor in risk factors, but this also points to the reason why you can’t always just go by principle either. One such case I had faced, given the potential of lay offs, which I saw way further ahead than most other people, but yet, it was still more down the road at that time, I didn’t worry so much about paying off the student loans, but rather was more focused on paying down the mortgage while also upping the emergency funding.

Mathematically, it would have made more sense to just put everything extra into the emergency fund, but from a risk stand point of view, I couldn’t do that. You may say it would have made more sense to pay down the student loans, but the need for the cash flow issue wasn’t an immediate issue, but rather a potential issue for down the road (hence what I hinted at with regards to future potential circumstances). Not only that, but while Dave believe everything in an emergency fund to go into a non-interest bearing account with no risk associated, well I have a problem with that as well. it’s cause inflation risk. While I put the money into other investments, thus I have market risks, I’m more willing to take that on than I am to take on inflation risk of non-interest bearing accounts. That’s cause one such reason for an emergency fund is to cover for long-term assets, but to do so, that means money has to be put into the account as such assets depreciate over time (Dave mainly just skirt this issue and don’t use it to mention anything about how to use this depreciation to account how much money to put off to the side over time for such long-term assets restoration/replacements).

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avatar dustintweir

I concur, but the person who manages his emotional thoughts with rational actions will go furthest.

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avatar boston renter

You are on the right track with trying to get people motivated to pay debt down the most efficient way possible. However I think you are overlooking the fact that many people are in debt *because numbers on paper mean nothing to them*. They weren’t worried about the huge numbers they were racking up on the credit card statement, because they were just numbers. If they cared about all that interest they are paying, they wouldn’t have gone into debt in the first place. They don’t get serious about debt repayment until the creditors are calling and getting nasty on the phone. Collectors yelling is real, numbers on the statement are not. So when it comes to payoff, the reduction in the number means nothing and isn’t motivating. They need the real life consequence of not having a bill to pay to feel good about what they have done. So, I think to get people motivated you need a concrete reward.

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avatar Denise

Mary Hunt of Cheapskate Monthly recommends the debt snowball. Her website has actual examples of how you will pay off your debt sooner and pay less interest. She used to have a sample calculator where you could enter your own figures to see it work. I have to say also, I find it more satisfying to have fewer bills to pay each month so I go with paying the smaller bills first. My only exceptions are doctor bills–if they are large bills I just make whatever payments they’ll accept because they don’t charge interest.

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avatar Ronald R. Dodge, Jr.

I use Excel quite extensively and unless you are in need of reducing your cash flow demands cause of your current cash flow sitaution, rate is by far the less expensive route than principle. However, that said, the reason why I mentioned about the cash flow thing, it’s cause if you end up having to take on more debt cause of your cash flow sitaution, then you will end up having more financial charges and fees. That’s why I personally allow for that one exception.

As for what works for others, it’s true, each household has to determine what works for them. Many people aren’t spreadsheet oriented and to make matters worse, very few are even familiar with formula writing within spreadsheets. As such, maybe the principle method is best for them. For me, the rate method is best cause I am very disciplined and I am not in that cash flow situation. Mathematically asside from cash flow issues, rate is better than principle. I will prove that over and over and over. But as others said, not everyone operate on mathematical grounds.

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avatar oldmiter

Troy, you must really be bad at math. In your example, mathematically it would be FAR superior to pay the car loan before anything else (at 8%, even without factoring any other tax issues, it’s the highest rate by far.). Your point about risk was well taken, but the example was so extreme, and either a typo or ignorance made you sound like you have NO understanding of math or finance.

Besides, someone with that kind of debt load would have to make more than 200K a year to come close to being able to pay the amounts you listed. Your example was not well thought out or very realistic. Also, even if you did choose wrong and focus on the mortgage, the minimum payments on those credit cards would have them balanced to zero before the mortgage was paid (in just over 10 years.)

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avatar john

you pay
1IRS
2 student loans
3 then your 1st

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avatar Ronald R. Dodge, Jr.

Not sure what you are refering to with point 3.

However, a lot of people won’t have to worry about paying the IRS (other than maybe state) as they are much more likely to get refunds than to have to pay the IRS extra come tax filing time.

As for paying off student loans, that’s last on my list. Take for instance, in 2010, I took the maturity date of the mortgage to be 29 months sooner by paying it down by about $9,400.00. That’s cause the mortgage has a higher stated APR than the student loans and the mortgage has NO tax benefit to me while the interest on the student loans does have a tax benefit to me.

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avatar Timmy

Flexo, does it make sense to get a debt consolidation loan and payoff all the debt in monthly installments in a guaranteed 2 year period. And then if extra money is available, even sooner, assuming that the load in an open one?

Thank you, your post was very useful to me.
Timmy

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avatar Awareness

Your Avalanche method works better mathematically, but is based on the assumption that people are rational and logical. Many people will also agree that they would prefer to do the Avalanche approach. It just makes sense, logically. However spending habits that get you into debt are emotionally driven. When you try to pit logical motivations against emotional motivations, in the long run emotions are going to win.

The logical approach will only work if people make emotional connections to it and break their other emotional connections to spending and saving.

Starting with small wins first, the snowball method appreciates the human element in this. It understands that most humans are driven more by emotions than by logic.

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avatar Ronald R. Dodge, Jr.

Actually, while you are sort of hitting it, you are still off.

Many people are too lazy to do things on paper or on the computer financially. They lay the claim it’s too time consuming, too detailed oriented, too complex, too much effort, too much like work, too whatever. Hence, it’s not so much an emotional thing as it is about effort. As such, the only real reason to go with the principle method, it allows them to have more of a cash flow freed up. That way if they mess up, they aren’t hurt as much by it with the finance charges as they just don’t pay as much to the one debt cause they got rid of the other smaller debts.

Me personally, I can’t live like that. the one time when I attempted to take short cuts cause it got to be too complex to do on paper, though I did realize the risk and took it anyhow, I got bit by it very hard, thus why I been doing everything within Excel ever since. I won’t even touch it on paper.

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avatar Luke Landes ♦127,372 (Platinum)

Timmy: Debt consolidation usually isn’t a good solution for the underlying problem, but it really depends on an individual’s unique situation. If you’ve tried unsuccessfully to get out of debt, I’d seek a professional debt counselor before thinking about getting another loan.

Awareness: “Rational and logical” and “emotional” are not mutually exclusive. Even people who are motivated emotionally can begin to understand the necessity of rational thinking in certain circumstances. In fact, they’ll need to if they wish to address underlying problems rather than just treating the symptoms of debt.

Also, I’ve already addressed the emotional aspects. There are ways to make the Debt Avalanche “work” emotionally as I wrote about above, without sacrificing the extra time and extra money required by other methods of prioritizing debt.

In some cases, people get into unmanageable debt due to *poor decision-making* which they rationalize by saying “I’ll pay it off later” or ignoring the consequences. Choosing a method that takes longer and is more expensive to pay off that debt, once they are ready to do so, is another case of *poor decision-making* rationalized by saying various things like “I’m motivated emotionally” or “Dave Ramsey says it’s OK.” Yes, even “emotionally-motivated” people “rationalize” their actions and decisions. (In some cases, people get into debt for reasons not related to decision-making at all, and that’s another issue.) You can be driven by emotions, that’s fine, but you can’t change your mindset about debt until you begin to think logically about money.

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avatar Micheal Smith

Flexo, you made it seem so simple. I have been tring that for over a year now but now i know where i went wrong. I wasnt paying the high interest debtors the major chunk as they never demanded more. Now i know why i’m in a soup. Thanks.

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avatar tvo

I wish I was reading blogs like this a few years ago. I wouldnt be in the shit I am now, owing more than $1,200,000 to friends, family and banks. I would know all the right steps, I would get motivated and inspired… Now all I have left is a site called http://www.savemefromshit.com, which is more an example of what to avoid in life, rather than a cry for help…

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avatar Evan

I am not sure why everyone has to be an all or none on this issue? While your math is impecable and can’t be argued (not even by Snowball addicts), life is not math.

I set up one which I am very proud – where I combined your logical thinking with the debt snowball. I put one CC which had the highest interest because I knew getting that off was priority #1 – then applied the debt snowball method.

Like most things in life – there are shades of gray.

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avatar Jason Beck

I’ve seesawed between the two methods. The psychological effect is as real as the math. For me, the issue is that the only revolving credit card debt I had was 1.99% and 4.9% forever. My student loans are 3.35% BEFORE tax deductions. My car loan is now at 3.49%. And my mortgage is at 6.375% (which is still the highest after tax deductions). So it really would be an AVALANCHE in that when I finally paid off the first debt, boy would my monthly surplus jump. But the rest of the debts would be paid off very slowly.

The reason I find it difficult is because this means I keep my current budget with a relatively slim margin, which means saving up for anything I want (such as that new bed you recommend) takes a long time because of the slim surplus. I get frustrated and out comes the credit card. If I pay off one of the smaller debts, I get to that larger surplus much faster, and maintain my discipline in saving for what I want… which as some psychological rewards of its own. I paid off all of my credit cards and am now wavering once again between whether I should pay off my car first or go for the big kahuna straight off. To help me make a better decision, I’ve started to bucket my debt payoff at ING so it can collect a little interest while I decide. Of course 3% (before tax on interest) is definitely less than either the car or mortgage interest lost, when I do take that bucket and dump it on a debt fire, I feel good about the decision and the process to get there.

(That and my stupid mortgage company charges $10 to make extra payments online. So I build up large chunks before making the payments.)

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avatar Ronald R. Dodge, Jr.

The reasons given by you about going the principle route, I allow for an exception dealing with having to free up cash flow demands when it’s needed. Your case may very well fall into this one exception on a temporary basis. Other than that, I would stick to the rate method otherwise.

As for your mortgage payment situation, why don’t you just use the online banking with your bank instead and have the checks sent to the mortgage bank so as to avoid that $10.00 online payment fee. I have had to do this with other debt. As for making extra payments on your mortgage, you simply up your monthly amount and also be sure to call the mortgage bank to be sure they don’t just apply the extra to your escrow but rather apply it to your principle as otherwise, they will play games like that.

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avatar Undercover Urbanist

So if you’re serious about reducing your debt, there is no reason NOT to take care of it the most efficient way possible.

You’re right- absolutely. But you’re a serious person who is capable of assessing consequences in your mind using a long-term, beyond-tomorrow-and-the-next-paycheck point of view. A lot of people are simply not serious about their finances.

There are plenty of adults who do not have the emotional maturity and personal discipline to make a PF decision based on the best fiscal consequences for themselves in the long term. In short, they’re children with jobs, mortgages, credit cards, and debts. These folks NEED Dave Ramsey to yell at them and play psychological tricks on them to break down the mental trap of “if I just don’t open my statement I can pretend the problem doesn’t exist.”

Some people who go through the Ramsey method begin to wake up from their PF nightmare and realize that the snowball method is costing them more than the avalanche, and switch. Most of the rest of them don’t, and need Ramsey’s methods.

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avatar RedDye5

You may be right, but I don’t respect the tone of your criticism. I have seen Dave speak (not about money) and he is very focused and inspiring.There are a lot of people who are not going BK because they found someone who speaks to them in a way that makes sense to them and offers quick gains, which turns the “start” into a “continue”.
You say that most people are smart. Then once they realize that the big interest rate is the dragon they want to slay (and your strategy is my own personal strategy that I thought up without asking anyone, and I’m just a girl…) then everyone’s happy.

Your attitude is that he’s an ineffective guy and maybe even borderline destructive. What’s destructive is people disagreeing over when, how, and whether they should get out of debt. Divorces happen because people won’t get on board and agree to get out of debt. He makes people want to be the one who gets on the radio and scream that they are debt free. I wish Governor Schwarzenegger would have been smart enough to listen to Dave Ramsey’s stupid snowball idea.
So, go ahead and criticize his inferior idea. We can all start calling you “Betamax.”

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avatar Crimson Falcon

Great method, I’m a bit confused on one topic…the emergency fund. The method is a bit unclear, do you send all money that you have in it over to pay your debt? Or is step one to build up an emergency find, and then never touch it? Only then after having the money in the emergency fund can you start working on the debt avalanche?

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avatar Luke Landes ♦127,372 (Platinum)

Ideally, the emergency fund should be funded prior to starting the debt avalanche. If not, any emergency would require you to start increasing your debt. Rather than waiting until you have three to six months’ worth of expenses in your emergency fund, I might start the debt avalanche a little earlier, perhaps after you have one month’s expenses in a savings account. Take into account your level of comfortability with the level of “insurance” your emergency fund needs to provide while balancing the realities of the need to get out of debt as quickly as possible. The debt avalanche works the best when you can put *all* your extra income towards reducing your debt.

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avatar Ronald R. Dodge, Jr.

With the Dave Ramsey program, step 1 is to first have $1,000 (which that really need to be $2,000 these days as his numbers are too much outdated) put into an emergency fund.

Step 2 is then to get rid of all debt except for mortgages.

Step 3 is to build up the emergency fund up to between 3 and 6 months worth of cash flow demands (He ignores the fact you also have to have money built up for thsoe long-term assets restoration/replacements)

Step 4 is then to put 15% of gross income into retirement funds (This again is outdated as it really needs to be 25%, but part of this 25% would be the employer’s matching policy).

Step 5 is then to fund your kids college funds (this one I question given the high cost of higher education compared to the low amount of additional income from employment makes it financially not worth it for most people, thus I would put this as step 6 instead)

Step 6 is then to pay off the mortgages

Step 7 is then wealth building.

For me, I don’t like to follow this strictly cause I found I have to use a balanced approach first cause things to happen and that $1,000 or $2,000 isn’t going to cover everything, and secondly, the mortgage is a higher cost than the student loans, so the mortgage makes more sense to pay off than the student loans. Not only that, but his numbers as I said are way outdated and don’t take into account certain risk factors such as the ones that specifically deal with employment years.

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avatar Wade

hy my cridet card rate went to 14.9% , $9.000 bal. I am thinking about a 0 bal. transfer for 12 months and pay every thing i can ever month (or weekly) tell payed off. that could be $1,000 to $2,000 a mounth. are there any of the zero transfers for 12 mo. out ther? Am i on the wright track? Wade

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avatar KS

I get what you’re saying and the math makes sense, but I think both you and Dave Ramsey push aside a few other concerns that (I believe) should be considered when paying off debt. Here are a few things I think should be considered.

1) Depending on when you got student loans and when you consolidated, the interest rate could be higher than interest rates on other debts (I have college students who have graduated in recent years with student loans with 12% interest, for example. My husband consolidated his monster loans at…8.25%. Mine, I consolidated at 3.5). But…the interest rate (usually) doesn’t change, forebearance/deferral are possible in case of job loss (not true with many other kinds of loans), and disability can cancel out part or all of the loans. I think getting out from under credit card debt even at lower interest rates is always better.

2) How much of the debt is to family/friends? Even if the interest rate is low, you might be better off paying this off early to square things with people.

3) Emergency funds: Having blown through our poor little baby EF TWICE in one summer (an appendectomy and a new unplanned-for roof), we’ve decided a larger cushion (more than Ramsey’s $1000) is necessary before we tackle the student loans. But we also have extremely secure jobs, so that tempers things a bit.

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avatar Ronald R. Dodge, Jr.

Just what I been saying with regards to Dave Ramsey

First, his numbers are way outdated. This $1,000 needs to be $2,000 these days.

Second, even though you may need to really hit the debt hard at first, you will find you will need to find a balanced approach between debt reduction, retirement savings, and emergency fund contributions.

Third, like you, though different, our mortgage is more costly even on a per borrowed dollar basis than it is with our student loans, so I will pay down the mortgage before I will pay down the student loans. Hecks, for that matter, the mortgage has NO tax benefit to me and the highest rate on our student loans is 3.75% with the lowest being 3.125% stated APR. Not only that, but the interest payments on the student loans are tax deductible before AGI. Therefore, on either account, the mortgage is much better to pay off than the student loans.

Fourth, even if I do lose my job, I suspect I should be able to find one fairly quickly given my set of skills with computers as very few people can match it, not to mention how versatile I am and me having very strong work ethics (thus why I wasn’t laid off when they laid off 74% of the work force last year).

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avatar Julian of Chicago

The snowball program is the way to go — with a few optional variations. Rank according to interest rate and then balance, but also rank according to credit card held the longest (or, credit card by an institution you have the “best relationship” with). For instance, a credit union (or any institution) that you have worked with and has been there when you have needed a loan. I would pay off a “best relationship” credit card (if the % is within 2% of your highest rate) because you set a new relationship record with that institution. I would then wait two months (keeping your paid-off card at a balance of less than $200). Then, (as most institutions allow — if not, ignore this suggestion), you transfer a balance from a higher yielding account to your “best relationship” account. The net effect is the same (paying off the higher yielding account — with a two month delay), but you also reaffirm your relationship with the proper creditor… You reward your friends and you let them know you’re responsible. This shows on your credit report; further, if you have a relationship with your “best relationship” institution for more than three years, your credit score may reflect this. -Julian of Chicago

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avatar Californio

The avalanche is the way to go for credit cards, but not for fixed period loans. For those, the “snowball” has a great benefit – it reduces our monthly minimum sooner. This is pretty important because our future income to carry out the avalanche plan isn’t assured. We have two student loans, one of 25k (2.5% super-low interest) and one of 150k (at 6% or so). We can nail the small loan in about a year, but the larger one is going to take awhile. Taking out the small one first lowers our fixed expenses sooner.

Total interest paid isn’t everything. Greater flexibility to manage expenses is quite valuable, especially with today’s job market. With the possibility of kids and other unforeseen family expenses, I figure we’ll end up taking our sweet time to finish off our student debt for good.

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avatar Ronald R. Dodge, Jr.

Be careful what you say, cash flow demands isn’t the same as expenses.

Technically, you lower your fixed cash flow demands.

Expenses are those that are reductions to your networth value costing you such as food, interest on any debt including the mortgage, other loan junk fees like insurance (yes, I seen insurance fees on vehicle loans too), utility charges, property taxes, insurance costs (vehicle, home, and health as examples), and entertainment. Therefore, be careful what you say about expenses vs cash flow.

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avatar TD

Mathmatically the Debt Avalanche is the best method and excellent for those who think mathmatically; however, not everyone thinks that way. There are regular non-math folks buried in debt, they know they’re in trouble, and disheartened by their situation who need the emotional boost from quickly knocking out a few easy to pay off debts. The value associated to the positive moral impact from this cannot be dismissed for these folks. They need it and it’s arguably more valuable than the few extra dollars they will pay by not being 100% efficient. I’m an engineer and respect the Avalance approach’s mathmatical effeciency, but even I use the Snowball method for a few just to get that Feeling of accomplishment.

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avatar derek

i have some unpaid debts bad on my credit report and i want to pay them off and i can but i dont know how to get in touch with who i owe money too? can any one help ?

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avatar Chazz

To locate the company or debt collection agency to pay your debts, I recommend the following strategies:
1. Try & locate the last correspondence received on each debt. That should provide a clue to what company/agency to contact.
2. If unable to locate previous correspondence, contact the original creditor of the debt. They will most likely provide the office/collection agency who you need to contact.
3. Since you’ve pulled your credit report, if there’s a phone number &/or address listed for the creditor/collection agency, contact the company that way. You’re bound to get some sort of response. And again, if all else fails, attempt to contact the original creditor via old statements, online contact information, etc. Sometimes you really have to be your own investigator! Best wishes to you!

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avatar Mike

Lets say you have a Visa, Gap card and and Best Buy for example. Well the high interests ones would be the Gap and Best Buy but they more than likely would also have the smallest balances. if you owe 25K to the Gap you have bigger issues than debt.

So pay off the Gap card, then the Best Buy then you will have more money to dump on the lower interest and higher balance of the Visa.
I totally believe that paying off your Gap card with the 495 dollars is going to give a person great satisfaction and motivate them to keep going.

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avatar Dane

These were all true. But I think paying just the minimum is not enough. People should try and pay more than the minimum if possible. Also, don’t be afraid to ask your friends and family for help. Credit card debt is a scary thing!

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avatar Ronald R. Dodge, Jr.

I never had the option to ask people for help outside of one relative paying for my rent while I was in college. As such, I have always had to fight my way through in life. Of course, what I deal with these days is very minor (even though I am still raising 5 girls with still having student loans and a mortgage to pay on) compared to what I had to deal with for the first 25 years of my life. To be quite honest, from the time I was 6 years of age up to the time I was no longer had the epileptic seizures via the laser brain operation, those 15 years were horrible years for me. Not really so much cause of the seizures, but more so cause of how I was treated by others with me having 3 life strikes and like in baseball, 3 strikes and you are out, thus how I was treated by others in life. As such, I had to learn early on how to fight for my ownself and make it through in life.

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avatar Bob

Huh? Was there actually a point to this comment??

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avatar Ronald R. Dodge, Jr.

On the one hand, other than for that one relative helping out with my shelter expense while I was in college, there was no one else to help me out with my living expense or with debt. As for me getting this help, I look at that as more of lucky for me than anything else.

One of many lessons I learned growing up as a result of what I had to deal with, you can’t depend on anyone for anything as people will do anything and everything they want to do for as long as the consequences aren’t great enough to deter them from such actions, even if it means they hurt others in the process.

As such, I had to learn not to do anything that could get me into a predicament of needing help from anyone, and yes, this applies to finances as well. I basically had to learn how to do it *ALL* my own self and depend on no one. As such, don’t depend even on your own family or friends for any sort of help. If you do, it often times comes with all kinds of problems that you don’t want to have to deal with.

Another thing, no matter how tough you may think you have it, there’s always something much tougher out there that is currently being dealt with. Like me having to deal with my own debt situation (More so as a result of lack of sufficient income for necessary living expenses) was minor compared to me having to deal with the issues that I had to deal with growing up. Therefore, when the tough get going, the going get tough. For me, I used the computer to majorly help me address the financial issues.

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avatar Larry Rios

Hello Ronald,

This is off the subject but I have a friend who’s had numerous unsuccessful sugeries for epileptic seizures. Can you refer me to your surgeon and hospistal?

Thank you,

Larry

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avatar Ronald Dodge

This was done with Dr Privitera as my primary physician (and he is still there) at UC University Hospital in Cincinnati, Ohio. Dr Yea was the neurosurgeon. The office itself is the Mayfield Neurology office on 222 Piedmont Ave, Cincinnati, OH 45219. Here’s the website: http://www.med.uc.edu/neurology/partners/mayfieldclinic/index.html

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avatar Joe

Did you have your eyes closed while reading this article? The idea is to pay the minimum on your lower interest rate debts, and use all the extra money to pay off the highest interest rate debts first. So please make sure you read the article next time before commenting and giving people a clearly invalid opinion.

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avatar Tom

Well this is called a Debt Avalanche. I understand your concern in regards to paying the minimum amounts (in traditional methods of paying bills) but remember that you are only paying the minimum so you can then put your remaining resources ($) towards the biggest interest % debts. I do not believe it was mentioned in the report but it is important to know that once one debt is paid off you then take the amount you were paying on the first debt and start putting that towards the next highest debt on the list. This is what creates the “avalanche” effect. The Avalanche will not happen if you pocket the money each time a bill is paid in full.

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avatar tony

It was sort of mentioned. By following the ‘rules’, the new ‘extra cash’ is not ever pocketed because the main rule is that all extra cash after paying for monthly expenses goes to the highest interest debt. It should go without saying that, for ‘spenders’, getting out of debt is a lifestyle decision and should be viewed similar to addiction behavior modification. It takes great will power and tenacity.

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avatar John

I struggled to decide which method would work best for me — as an engineer I was drawn toward the avalanche method, but I also thought there is something to buying mental victories via the snowball method. In any case, I needed to get some actual numbers down to help me make my decision. Overall, assuming that I would continue to pay at least what I pay now as the minimum, I found that I stood to save at most $623.72 on my 8-card $33,355.80 debt. I would arrive at this differential-savings high-point by paying $671.78/month for 5 years, 2 months. Realize that this savings advantage — between the snowball and avalanche — shrinks as your payoff duration decreases. I was slightly disappointed because I actually thought the savings potential would be higher than that. In any case, analysis can be found here: http://breadfromscratch.com/tools/credit-card-repayment-calculator-debt-snowball-versus-highest-interest/

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avatar Dusty

When I woke up August 2008 and realized how foolish I had been with my credit cards I created a system that would work for me. Only after that time did I start reading about Dave Ramsey and avalanche approaches to paying down debt. I switch it up, I made choices that worked for me, and I made some choices others say DON’T DO, but I had to make those choices. August 2008 I had a mortgage, a bike payment (stupid purchase), 10 credit cards, 3 high interest lines of credit, and one bank loan. It was exhausting keeping track of those bills along with utilities, cable, food, fuel etc. So I took out a home equity line of credit and combined the 3 high interest, and one bank loan. I refinanced my bike loan with my bank at a lower interest. I listed my credit cards by lowest balance. It was slow the first 5 months but in February 2009 I sat down and reviewed my progress, I switched it up some, sold the bike, went to my bank once again and took out one loan for a credit card that was adding more to my “advances” each month. November 2009 I refinanced my home to a lower interest and included my second mortgage. Today I am down to one mortgage, 3 credit cards, one bank loan. I am now focusing on the highest balance card. I send double payments to 2 and triple payment to my largest. I am down nearly $19,000 of over all debt. Nearly $82,000 at the beginning and now at $63,000. and most of that was really between February 2009 to June 2010. It boils down to what works for you, not others.

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avatar Darlene

Thanks for your suggestion. My head was just starting to spin as I was trying to wade through the information I already have and researching other methods in order to make the best fiscal decision for me. I am working hard to be more financially responsible and clawing my way out of debt slowly but definitely surely. Your words gave me the confirmation that it indeed boils down to what method works best for you and not what others tell you. THANKS and good luck at working your plan. (From the looks of it, I don’t think you need it! :)

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avatar cindy

This was really inspiring, I have a visa that I owe $2,480 haven’t been able to make payments but I’ve talked to the debt collectors and im so lost with everything. I’ve tried to transfer to another credit card but I only got a credit limit of 300. Do you have any suggestions as to what I can do? Im a college student and my funds are really limited and the debt collectors are asking for the whole amount which of course I am not able to get.

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avatar The Latter-day Saver ♦706 (Dime)

I agree that people should do WHATEVER method gets them out of debt. I like the avalanche method for my family and me.

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avatar Ronald Dodge

I took the FPU course with my wife as I more or less forced her to take it. Main reason for me having her take it was cause I was sick and tired of her thinking all of this financial stuff I had been doing in Excel was just some made up stuff in my mind. She dreaded it at first, but after the course itself via the video showed some real life experiences and others in the classroom shared their experiences, it made it all too real for her as it reminded her of the various things we went through. This was the purpose of me having her to go through the course as I had to have her realize what I was doing was the real deal, not just something made up in my mind. She came to that realization pretty early in the 13 week course.

As for the debt snowballing area, I’m with you as I don’t agree with Dave’s method. Not only does Dave highly recommend the principle method, but so does Primerica, which I also refused them with this principle method.

Like you pointed out in this article, I also take taxes into account. As a matter of fact, I even took it one step further. Within my Excel financial file, I have done the following:

Column A: Debt Title
Column B: Debt Principle
Column C: Stated APR
Column D: Before Tax Basis Effective APR
Column E: “Yes or No” answer – Is it Tax Benefit (Example, Student Loans, Yes, Mortgage, No (The Schedule A has never been of help to us, even under the 13/11 month game)
Column F: After Tax Basis Effective APR
Column G: Minimal Monthly Payment
Column H: Principle Reduction
Column I: Daily Savings on Interest with Debt Payment

Why do I have Column I thrown in there? Well if you know how money works, you know it works more on the basis of percentages than it does on absolutes. Therefore, the higher we can get those daily residual savings in, the better off we can be. Over the course of the year, I set the goal to be a minimal of $3.65. To some that may seem a small amount, but think about it. If you have a debt with an ATBEAPR of 10% (using this rate for simplicity purposes when it real life, it may very well be a much more decimal type number), for every $10 you pay off on the debt, you save yourself $1 over the course of the year, so to save $1.00 per day or $365.00 over the course of the year on interest, you have to pay down the debt by $3,650.00. Another words, if you were using strictly this debt to save you a daily interest charge of $3.65, you have to pay down that debt by $13,322.50 over the course of the year. The lower the rate, the more you have to pay down the debt or pay into the investment to achieve that $3.65 daily residual amount goal.

Don’t kid yourself, you do have to convert everything to after tax basis before you can tell if you are meeting this $3.65 annual goal or not.

There are 3 major issues I have with Dave’s FPU course:

First, it’s too risk adverse. It is truely a cash flow method that even under my retirement self study has already proven to be too slow of a route to secure a retirement security when you throw in life circumstances one is faced. For me, I use my method, which still greatly take risks into account, but it’s what I call the equity method as it’s main goal is to shoot the Long-Term Networth value up as high as it can without taking on too much of a risk that may hurt this value in the long run.

Second, the numbers in that course are too outdated. Examples:

It’s baby step 1 says to have an emergency fund of $1,000. That may have been true in the 1990′s, but not now. Now, this step should read as a $2,000 level.

It’s baby step 4 says to ultimately get to 15% of gross income into retirement funding. Again, this was the most you were allowed back in the olden days prior to the 2003 bush tax law changes. However, under my self study of retirement, I found 25% is the ultimate goal, but even after the initial 5 years out of college, you at least need to have 25% of actual gross income (that is including the money the employer put into the retirement account on your behalf) must go to countable savings (Net contributions into retirement funding including the matching money from the employer, net debt reduction, and net emergency fund contributions). Why not within the first 5 years out of college, generally your income start out really low and you are jacked up with high debt of student loans to the point the government of recent even subjected the CEOs of these various colleges and universities they are charging way too much and thus these people with these high student loan debts are defaulting on them majorly. Therefore, the first 5 years of one’s work career, they are in too much of a financial dire strait to even think about putting money into retirement debt. Yes, I was one such person specifically in this boat and I’m still paying on such student loans for another 8 years or so yet.

Third major issue I have with his program. While it’s true, his method allows for one to do things without having to think about it daily, but once again, his program is behind times, and you can now use online tools to schedule your payments in advance of time. As such, now you can use the rate (ATBEAPR) method primarily to determine how to pay down your debt.

The only caution I throw in there, if you have a debt with transaction fees for extra payments (I.e. 401(k) loan payments) and/or early pay off penalty charges, you must be careful and really think it through if it’s worth it or not. In my case, I had to face them both and for them both not to be worth to take on such fees. Even with the one dealing with the van, I had to be smart as to how I dropped the debt on it and believe it or not, for a loan that was expected to be paid off in 5 years, I shaved off 5 months worth of payments (that’s money saved and not paying into interest by turning their rules around to work for me instead of for them). I still don’t have it entirely paid off, but the balance on it is so low, the interest charged on it is negligible on it. To avoid that early pay off penalty charge, I have to wait until the earliest possible time I can pay it off without getting hit with that $125 charge. The rep claim one year left on the loan is when it will fall off, but the paper work says it’s 6 months left. Either way, I’m covered as I already paid it down in a manner I have given myself some cushion room.

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avatar TheGooch

David Ramsey’s method is about changing behavior, not just paying off debts and creating emergency funds. The initial emergency fund should be $1000. It’s created to get you in the habit of saving money, and to provide buffer between yourself and emergencies. However, he says that you should increase its size later.

Most people I know make 2 emergency funds:
1) Unplanned expense emergency fund
2) Job-Loss emergency fund.

3) The other idea I subscribe to comes from Youneedabudget.com, which has you create a buffer equal to 1 months income. This is used to fund next months expenses, so that you are always pay this month’s bills will last months money. It’s another way to stabilize your money flow as you don’t have to worry about how much you will have to spend…you already know that.

4) Finally (for me) , the debt snowball. You can choose your strategy, but I found that having 20 creditors that I owed small amounts to calling me, sending me collection notices/threats, making entries on my credit report, etc. was worse than paying more in interest. So, I went after the small debts first. I found I knocked half of them out in the first 3 months. Not having to deal with them lowered my stress level big time, I slept better, and my quality of life improved greatly.

As I continued down the line of small debts, I found it took much less time to take stock of my debts and decide how to pay them, or who to call because I couldn’t pay them due to an unplanned expense. So that management of my debt was much simpler as well.

My mini-emergency fund will be done next month, and I’m way way more in control of my finances. I finished off 3 more small debts this month,and plan on knocking out 1 a month for the next 3 months.

This will leave me with 5 fairly large debts to pay off. With the free time I have since I don’t have to deal with a million creditors, I can work on negotiating lower interest rates, getting a second source of income, and look at different strategies in paying them off sooner.

If I had gone after the largest debt first, I’ll still have several years left to pay on it, and still have 20 creditors breathing down my neck, and probably I would have jumped off a building by now.

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avatar Ronald R. Dodge, Jr.

Why I say $2,000 for the first baby step?

Let’s say you have a major vehicle problem. Now days, you might get lucky with that $1,000 amount, but most likely, you are going to be more like in the area of about $1,500 like with a transmission or engine issue.

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avatar Ronald R. Dodge, Jr.

Well congrats on how much progress you made at this point of time. As for you doing the smallest first, I normally would have been against it, but in a case like yours, I could see why you would do that for various reasons. If you have small debts like that that can be knocked out within 3 months, then it generally means they are of the insignificant effect when compared to the big picture.

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avatar TheGooch

Well, once you realize there is more to the equation than interest and fees, you’ll understand that it’s not as simple as choosing the debt with the largest interest ( you can have a gigantic interest-free loan, and several smaller but interest-laden debts, so then paying the largest debt will not save you any money on interest, this happens to be my case ). There are factors such as fees, how many hits on your credit card ( do you want to have 4 ( 3 small + one large ) or 1 ( just the large one ), the management overhead for keeping track of all of these debts, and handling issues with them. For example I have a creditor that I made a deal with , and they said the paperwork had to go to another department. Two weeks later, I called because they didn’t process my payment, and they rep said for some reason it was never sent to the other department. Another two weeks pass, they withdrew the amount of the first payment in the payment plan, but I get a threatening letter saying I am delinquent in my payments and must pay the entire balance in full now. Since I’m in Asia and have to wait for the office in the US to open(13 hours time difference ), its quite a hassle to have to keep going back and forth like this. Now imagine I had the choice of having 20 accounts like this to deal with, or 10 ( because I pay the small debts off first ).

Personally, I’d rather have the 10.

Then there is the psychology behind it. Some people are motivated to go forward by positive feedback. A number of quick wins makes evident that they can achieve their goal, and it’s been show in studies to build an “addiction” to paying off debt. Often slow progress builds a sense of hopelessness, even though you can show them that balances and fees are decreasing, they still don’t get the same satisfaction as the words “paid in full” bring.

Finally, I leave with Sun Tzu’s ( Author of “The Art of War” ) strategy of throwing your strongest forces against the enemy’s weakest point. It works.

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avatar Ronald R. Dodge, Jr.

With that second to last paragraph of yours, you are right, many people are driven that way. For me personally, I am not driven that way. If I had to deal with creditors like that, then I would be like you, get rid of them creditors as quickly as I can. On the other hand, I’m not in that boat.

One more thing to think about, there are also other debts like debts against 401(k) plans, which if you pay extra on, you also end up paing something like a $15.00 transaction fee per extra payment, thus from a mathematical point of view, does it really make sense?

I know when it comes to 90% of the people in this world, it seems all logics goes right out the window, thus why people like Dave Ramsey says it works so well, it *MUST* be the best way. Well it may be for the 90% of the people in this world, but not for the other 10% that are logically driven. For me, that bottom number is the only thing I really care about, though I certainly look at other aspects of the family’s financial health, but ultimately what really makes the difference is that bottom line. The problem I have with people like Dave Ramsey, since this works for the 90% of the people in the world, he attempts to lay the claim it works better than the rate method for the other 10% of the people in the world as well thus attempting to stuff it down people’s throat that are rate minded.

Like you said, even though I am primarily rate minded meaning I primarily go in rate order, I also take other things into account that could change that order for one reason or another, which I have had to revert to that from time to time.

Speaking of psychological aspects of the human body, let’s look at another one of Dave’s comments that I also don’t agree with.

His argument for renting vs owning:

You rent until you have all of your debt paid off and you have saved at least 20% down payment on the home itself including all of the extra fees with it.

Mathematically, this could be very well argued from both cash flow and risk factors. However, if you had to deal with slum lords like what I had to deal with, this whole argument goes right out the door cause who wants to continue being a tenant if from landlord to landlord to landlord, they keep attempting to blame things onto you as to it’s your fault as to why certain things are not working properly or why there’s a crack in the foundation. They don’t maintain the building and when they do have the so called maintenance guy over in the dead middle of the winter to fix something in the rental, the maintenance guy leaves the windows wide open, which then leaves the home and still leaves the windows wide open only for you to end up having a much higher heating bill. After having to deal with such issues for a period of 12 years (much of those years were on a basis that my income was too low to even cover necessary living expenses thus a relative had to pay for the rent). The last slumlord I had was even worse. He not only had those things done, but he even attempted to play the late game with my rent payments, thus whenever he claimed my payments didn’t get paid on time, I relied on the bank’s online banking guarantee with online payments. I followed the rules to the T and thus I had a valid means as to my payments at least based on my instructions were “ALWAYS” ontime. As such, I not one time had to pay the late payment fee as done via the bank’s guarantee with it’s online payment program, which the slumlord attempted so many times to get me to pay such fees along with sending out 3 day eviction notices for failure of payment. The last time he did that was when we had given our 30 day notice and he instantly out of retaliation sent us a 3 day failure to pay eviction notice.

As such, even though I was logically looking at total cost of renting vs total cost of owning a home, I had this major emotional drive to get out of the renting business as a tenant. While the owning worked out to be less cost over all than renting, we still took on a major risk that we would be able to keep up with the mortgage payments along with everything else. We ended up taking on a greater risk than what I wanted to take on, but I was so driven emotionally to get out of the renting business, I in many respects really didn’t give a care as long as it wasn’t going to land us back into the renting business as tenants. Therefore, even Dave’e deciding point of when to go from renting to owning was not even going to come close to be followed cause of all the BS we had to deal with as tenants. That right there is my single biggest reason for leaning to ownership. While I would primarily have the total cost of renting to owning being the primary decision factor with risk factors thrown in to be taken into account, you got this psychological factor of having to deal with such slumlords too.

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avatar TheGooch

Now that I have my debts pretty much under control by getting rid of the small ones quickly, the overhead of handling a large number accounts is gone and I can plan a lot better. Note that interest rate/fees and balance are 2 different things, and you may have 0-interest debt ( like items in collection with a payment agreement ) and interest debt ( mortgage, revolving line of credit, etc ) .

That said, I’ve changed my strategy to consider fees/interest as well as balance. If 2 debts have a similar balance ( this is highly subjective ) but one is costing more in fees, then I would recommend paying minimum on the low fee one and as much as you can on the high-fee/interest one, even if that is out of order for the snowball method.

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avatar Frodo

your plan to consider the interest rate on two debts that are similar in balance is actually part of the snowball method. Dave Ramsey says that when ordering your debts in order of balance if two have a similar balance you should list the higher interest rate one first as it will save you interest payments in the long run! So you are still using the snowball method when doing this. Great job!

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avatar dawgette ♦199 (Cent)

I had not heard of this approach before. Good article. Thanks for the information.

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avatar Michelle Owens

Thanks for the article, this gives me a good place to start. I have 2 credit cards neither of which I felt like had unmanageable balances until I started considering how high my student loan payments might be when they begin in 3 months. Reading this article makes me feel a little less anxious, and a little more prepared.

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avatar Paul

Question – I have 2K on a credit with 0% interest for a year and a car loan of 3K with 5.4% interest on. My wife and I will owe big on student loans in Janaury and I want to get my car and/or credit card paid off fast. Should I pay extra on credit card payment or car? How important is it to pay off the 0% in one year, the interest will shoot up to 10% in April 2012.

Thanks

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avatar Luke Landes ♦127,372 (Platinum)
avatar Ronald Dodge

It’s really a depend type question. Initial response would be to get the car paid off first, but without knowing your cash flow situation (inflow vs outflow for the time period of the 0% APR). However, one thing about that 0%, if the terms states as if you don’t pay it off in full by the end of the promotional time period, then you will owe interest that incurred during the introductory time period, but wasn’t shown to you as an expense given you were in the introductory time period. Given the rates of most of these promotional things, that’s quite often a very high rate and it’s a big money thing for them. Therefore, if there is this back interest clause in your contract, then it’s very important to pay off this debt before this 0% introductory period comes to an end.

With this in mind, this may mean instead of paying off the extra to the car debt, you may need to save this extra to a saving account that may earn you a very small amount of money until you build up enough money to pay off this 0% APR debt in full (Before the end of the intro period), so as you avoid the big interest charge that would take place otherwise once the end of that period has past.

Of course, for you to figure this out, you need to know your cash inflow, your necessary cash outflow and your other cash outflow demands, which then to determine what you can and can’t do along with determining what’s best financially for your household. I know this sort of thing isn’t the easiest to figure out, but it’s the number one reason why I use Excel for my financial stuff. Rather than me having to do all of this stuff myself, I just simply setup the calculations and let Excel do the calculations for me.

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avatar Cody

Hello,

I’ve been reading articles about paying off debt quite a bit. I’m not in a whole lot of debt but I feel like I can never get out of it. I have two best buy credit cards that are interest free as long as I pay roughly $80/month due to the promotion they had going on, one has $750 and the other has $1400. I understand that’s basically free money but I hate having that debt over my head. I also have a visa credit card with $3000 on it, which doesn’t start accruing interest until September which will be a 17% interest rate. I have about $500/month available to pay off debt. Which one goes first?

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avatar TJ

I’d pay the minimum towards the Best Buy cards and blast out the Visa card as quickly as possible. That 17% is a killer.

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avatar TJ

I have opted for a hybrid method between the snowball and avalanche. My wife and I have student loan debt and a mortgage, that’s it, although the student loan debt is high about $80,000 EACH. The credit card debt of $11,000 that we had is gone, that was priority. Then came the private student loans with high interest, a $7500 one is gone and another that was $22000 is now at $15000.

Right now we are probably following the avalanche method in part by paying the mortgage+ $100 extra per month to eliminate a few years off the 30 year fixed at 5%.

The student loans have the highest interest, the private $15,000 is at 8%, mine at $80,000 is at about 7% and my wifes at about $80,000 is at 5.75%

Right now I am sending $2500 per month to my $80,000 loan and at least $1,000 to the 8% loan. My concern here is more with the total amount of interest that racks up on the higher loans, combined with eliminating the highest overall interest rate loan. So it’s a combo method that includes both elements.

However, one of the loans at $80,000 I leave in forbearance, this is the lowest interest rate student loan. The idea is to pay off the higher interest lower balance $15,000 loan and then tackle the larger one later.

So basically I owe and pay the following

235,000 mortgage, pay the “minimum” 30 year payment with + $100 to pay down some principal
80,000 Student loan at about 5.75 in forbearance
80,000 Student loan at 7% pay $2500 per month total interest per year is about $4,500 everything else pays down principal
15,000 Student loan at 8% pay $1000 (sometimes more depending on second job income)

So I think I have combined both methods. I still poke some money into a high yield savings (wow about 1%). So psychologically this works because I can see at least one large balance dropping dramatically (the 80,000 loan I give $2500 to per month used to be $105,000 less than a year ago) I am still saving money each month so my savings rises, and I can see a smaller loan (the $15,000 loan) being wiped off in about a year. Then that income will go to the second $80,000 loan which will get eaten down some while the other large loan gets paid off.

An alternative I thought of is to take each and pay all available income to just one and wipe each out quicker. Since Student Loans with the Fed can be put into forbearance then this was tempting. One would dramatically drop while the other only rose slightly (since student loans are not revolving credit accounts).

It was also tempting to forget the student loans and pay off the mortgage, then the student loans. The logic being that the house is a tangible item that can be taken back in hard times, while student loans can be easier to deal with. We have been burned in the past by sinking money into housing that then disappeared to the tune of $60,000. So that experience taught us that real estate is volatile and that equity isn’t a guarantee. So we decided to attack the student loans but give a little to the house.

Thoughts ideas?

Appreciate it, we are both in non finance related fields and appreciate the assistance.

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avatar Ronald Dodge

as for the $80,000 with 7% stated APR vs the $15,000 with 8% stated APR, I would at this point pay the minimal to the $80,000 and pay the extra to $15,000. Under both rules (Avalanche-Rate and the Snowball-Principle), it would say to pay off the $15,000 first. The Avalanche-Rate says cause the rate on it is higher than the rate on the $80,000, thus you will save on total interest charge overall. The Snowball-Principle would have you pay off the $15,000 first cause it’s closer to being wiped out, so it would free up cash flow sooner as it would drop your cash flow demand that much sooner.

Note, in most cases, I would go with the Avalanche-Rate method, but there are cases for going with the Snowball-Principle method. However, before you decide which way to go, you have to look at your household’s set of circumstances and decide which way to go, which there are 3 basic ways to go with regards to being financially prudent depending on your household’s set of circumstances.

1) Put so much money into an emergency fund (which I’m assuming that’s what your so called high yield saving account is for) for when something happens, you have something to fall on. Like in my case, I have an emergency fund of about $13,000 that is mostly invested, but also easily converted to cash with very low cost to do that. Don’t get me wrong, I still have taken some risks with the route I have taken, but I would rather take on market risks than to lose to inflation risks.

2) If you feel there’s some eminent risk to your current cash inflow (i.e. unemployment) or some other major cash flow demand (i.e. vehicle repairs), and you not sure if you going to be able to get the cash freed up in sufficient amount of time, then you may choose to take the snowball-principle route so as to get rid of debt quicker, which then will reduce your cash flow demand faster initially even though it will end up costing you more in regards to total interest you pay. However, by going this route, you may also potentially save yourself from having to take out other debt that would incur other fees and interest charges. Not only that, but if your situation looks to be pretty bleak, you may end up having to get rid of the smaller debts not only for the cash flow demand reason, but to allow you to make it through that much more easily. Example, if you end up having to rely on the state/federal welfare system, you can’t have more than $2,000 in countable assets including your emergency fund, so you may be forced to pay down your emergency fund to get any sort of welfare help from the state/federal. The other thing, the welfare system doesn’t take into account any of your debt(s) except for your mortgage (if you have at least one), which they only allow for one mortgage. I know this is not an ideal way to go, but there are such cases you may have no choice but to go this route. However, be very careful you don’t get caught trapped in the welfare trap with these rules, which many people do fall victim to.

Side note: I have been notified as of mid part of next month, I will be laid off, so I am having to do what I can with what I have in my control. With what I have done thus far with raising a family of 7 (my wife, 5 girls and myself), in theory, I should be able to last for a minimal of 9 months should things end up getting bad, but I really don’t want to have it come down to that. However, even with that, it would mean my networth will be depleting faster than what I would like it to be. Therefore, to counter act that and knowing the welfare rules, I may pay down my mortgage enough to get rid of the MIP and pay off one of my student loans so as to greatly drop my cash flow demands while then allowing us to qualify for this welfare help on account of us no longer failing on account of that $2,000 countable assets rule. By doing that, it would allow us to get the help, which then would keep the networth from dropping all that much even though our daily residual improvement goal would be greatly hurt by this move cause of us having to give up the residual income that I have been getting from the emergency fund (which I estimate to be about 7% return after tax basis to be on the conservative side even though I actually have done better than this. I would rather be conservative than over zealous).

3) If you are in pretty good shape with a healthy emergency fund in relative comparison, you can take the Avalanche-Rate route and really cut down on your total daily interest charges. From strictly a financial or mathematical stand point of view, this is by all means the most preferred route, but if there are certain other things that are weak, taking this route can end up costing you more with regards to other angles of financial fees, especially if you end up having to take on other debt cause of some other situation happening that requires you to come up with some significant amount of cash rather quickly.

Example with my current case. I had been using the Avalanche method, but as of late last year, I been having to switch gears cause of things I saw at my place of employment I have not liked and me seeing those things in advance of time proved to be right. As such, I have been building up my emergency fund and allow me more options should things happen, which obviously they have now been put into action to happen.

One of the things I learned back in the 8th grade as a result of how I was treated by the school officials with me having 3 life strikes (epileptic seizures, learning disability primarily in language, and being a ward of the state or foster child), one much learn the adult’s game, strategize within the rules of the game (heaven forbids should you break one of those rules), and ultimately beat them at their own game. What forced me to do this was when they were attempting to hold me back laying the claim I couldn’t do anything including my strong subject matter areas, which I ended up proving them wrong in so many ways they had no realistic choice but to admit they were wrong for applying those myths to me. Same here with this financial stuff. Learn the rules of how finances/money works, how the creditors work, and how the government work, which then work the system to your advantage. While you do things that should be right for all people, but if worse comes to worse just as they did for me when I was a child growing up in the public school system with nearly all of them treating me like I couldn’t do anything cause of me having 3 life strikes (Like in baseball, 3 strikes and you are out), then you have no choice but to turn to such down right playing the rules against the ones that’s attempting to hold you back. With regards to finances, I apply many of these rules to better ourselves while still being fair to the creditors.

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avatar Matthew James Murrian

Make the payments as you currently are, if that is what you can support. Your total monthly payments total roughly $4850 given what you’ve said.

At this rate you’ll pay off the $15,000 student loan around October 2012.
Once you free up that $1,000 then you should apply it to the 7% student loan (on top of the $2,500 you are already applying).
Paying that $3,500 into the 7% student loan, you should pay it off around December 2013.
Once you free up that $3,500 then you should apply it to the 5.75% student loan. That will allow this loan to be paid off around April 2016.
At that point if you direct the entire $4850 into your mortgage then you should be able to pay it (the final item of debt) off around April 2020.
This approach will yield you around $100,000 in accrued interest.

This payment approach is based entirely on minimizing accrued interest assuming monthly debt payments of $4,850 … by the numbers. No consideration was given to preferentially paying off the mortgage first or last.

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avatar FGM

Here’s a question that that I have not been able to find an answer to.
Instead of either method, what about putting whatever extra money available monthly on the debt (credit cards in my case) in order of the HIGHEST MINIMUM amount due. This may not be the smallest total amount owed (Snowball), nor the highest interest rate (Avalanche). Once that comes down to a monthly minimum payment equal to the next card in line, then tackle the one with the highest interest rate of those two, etc. I can see the possibility for yo-yoing the various CCs as the minimum amount due change – so maybe more labour intensive. Is this a good approach – does this have any advantages or disadvantages over the other two plans? Thanks!

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avatar Matthew James Murrian

I ran numbers to test the theory on both Snowball, Avalanche and, what I call, Power method. Power method prioritizes the debt where the payment would give the largest reduction in daily finance charge.

For example, $25,000@5% costs $3.34 a day.
If you pay $1,000 towards it, $24,000@5% costs $3.20 a day.
So, the power of $1,000 applied to this debt is $0.14/day.

$5,000@15% costs $1.91 a day.
If you pay $1,000 towards it, $4,000@15% costs you $1.53 a day.
So, the power of $1,000 applied to this debt is $0.38/day.

Given the choice, $1,000 does more good on the $5,000. These examples are rather obvious and Debt Snowball or Debt Avalanche would lead you to make the same choice.

Here’s the kicker … for a given interest rate … the “Power” that a $1,000 payment has on reducing finance charges is the same, regardless of actual account balance. It might not make intuitive sense but, whether you knock $25,000@5% down to $24,000@5% or you knock $2,000@5% down to $1,000@5% … that $1,000 is reducing your daily finance charges by $0.14 in either case. Paying the $1,000 towards higher interest rate items givens you a larger reduction in daily finance charges.

Debt Snowball might be good psychologically for ‘quick victories’ but Debt Avalanche will result in less interest paid. If your debts happen to have higher account balances associated with lower interest rates (which is not uncommon… think new car loan vs used car loan, home mortgage versus payday loan) then there is really no difference in either approach.

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avatar Ronald Dodge

Other than for psychological situation, there could be other reasons for doing the snowball (principle) instead of avalanche (ATBEAPR or After Tax Basis Effective Annual Percentage Rate). It could be either 1, they need to free up cash flow to get them on better ground (hence they may have to go this route to help them avoid other potential finance charges that they may potentially incur otherwise with the rate route if they are in this bad of a situation), or it could be they need help from the welfare system to help pay for necessary living expenses, but given the welfare laws don’t allow for good finance practices (in particular allowing for a sufficient emergency fund given the household is ONLY allowed $2,000 of countable assets which includes the emergency fund as countable assets and like in my case, $2,000 is only about 3 weeks of total household cash flow demand for a household size of 7), and given no debts other than the mortgage is taken into account, one may have to spend down that emergency fund to get rid of as much of all of the other debts in order to get the financial assistance they need for their necessary living expenses while also freeing up their cash flow demand in the same process.

I don’t normally like to advocate feeding off of the welfare system as it’s really more of a financial trap, but there are cases when one may not have much of a choice but to go that route on a temporary basis. Why it’s a trap? While they claim it’s to help those that really need help, in practice, once people get onto it, they generally get stuck on it cause most people are like, why should they go back out there to work if they get more taken from them than what they get from employment. Not only that, but if you are attempting to help yourself, you get left out in the cold in most cases while if you don’t attempt to help yourself, then they do help you out. These are the 2 major issues with the welfare system that makes it more of a financial trap.

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avatar William

Can anyone tell me^ is it better to pay off closed accounts in collections in payments or all in once? Which one will make my credit score go up?

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avatar TJ

Be careful. If the account is old then let it go, it won’t show after they are seven years old (regular accounts). They will still try and collect for years but if you do not set up payments or do anything new with the account they it won’t go back on your report.

That being said, if they are relatively new 2-3 years (depending on how much the accounts are) you can call the creditors and work something out to pay them off for less. Go to a credit counseling workshop in your area. Most are non profits and so forth but you can negotiate on your own. Most of the time they will take less in a lump sum and the account will then show positive. Payments are not a bad idea because they can help rebuild credit and build a positive payment history.

So go get some credit counseling and DO NOT pay for it. Call the legal aid group in your area and they will have a referral for you. Start by calling your local superior court and they can refer you someplace too.

Don’t agree to anything with creditors unless you get it first in writing and you can review the terms.

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avatar Pip

I don’t understand the advice to use your emergency fund to pay off debt. Sure you won’t make as much in interest in a savings account as you would save paying off a chunk of debt, but as I’m sure we’d all agree, the first step to killing debt is to cut up all credit cards. Now if you’ve used your emergency funds to pay off debt and then something happens, what exactly are you supposed to do? You now have zero dollars and zero credit. You’re screwed. I try to keep in savings *at least* the amount of 1.5 months rent. I don’t drive a car, so to me housing is the biggest and most important expenditure. With that much ready cash, I’m prepared if my housing situation should suddenly change for any reason.

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avatar Matthew James Murrian

I just ran some computer code to crunch the numbers of this discussion. I simulated monthly payments being made to items of debt (each item of debt having its own ‘minimum payment’ on its own given day) and a large ‘debt reduction payment’ being made on a given day every month to a given debt item.

The selection of which item of debt the ‘debt reduction payment’ was being applied to was chosen based on:
1. smallest balance,
2. highest interest rate,
3. highest daily finance charge,
4. no particular reason (that is, simply chosen based on being first in a list),
and for kicks,
5. largest balance,
6. lowest interest rate,
7. lowest daily finance charge

If this ‘debt reduction payment’ ended up paying off an item of debt without being completely spent, the remainder would be applied to the next highest priority item.

The simulator was also run with and without ‘catch-up payments’. The catch-up payments were to ensure a certain minimum amount was being applied towards the bills monthly. That is, if an item were paid off in a previous month, with ‘catch-up payments’ the funds no longer being applied towards that previously paid item would be applied to something else … or without ‘catch-up payments’ a paid item would result it progressively less money being applied towards debt reduction with time.

The list of debt items that I used were based on my own financial situation. Generally, the larger account balances are associated with lower interest rates.

In the end I found that, at least for my situation, it doesn’t much matter whether I pay off lower balance (debt snowball), higher interest rates (debt avalanche), or higher daily finance charges (lets call it the power method) first. It does, however, matter if I choose to prioritize debts in the opposite manner … higher balance, lower interest rates, or lower daily finance charges first. So, as far as choosing which to pay towards first, it doesn’t much matter which of the sensible 3 methods I choose.

The most important thing in paying down debt faster and with less interest paid is the ‘catch-up payments’. As you pay off one debt, apply what you would have paid for that debt to something else.

In short, it doesn’t much matter what you pay the $2000/month on first … only that you consistently spend down $2000/month.

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avatar Ronald Dodge

If rates and balances are either relatively close or balances or time duration are relatively very small, then it more than likely wouldn’t make much of a difference. However, if there are significantly larger rate differences with larger balances over a longer time periods with significantly different maturing dates between the different loans, then you will have the opposite end of the spectrum being true meaning the avalanche method will show much more improvement than what the other methods would do unless there’s some other financial situation that would trump the avalanche method such as early payoff penalty charges, then that would have to have a second look to see how that may change the ordering of the debts and rather to pay off such debts sooner or not.

I don’t know what numbers you are using, but for the most part with my situation, our household networth at it’s lowest point in February 2001 (by the way, this was when my income went up significantly to the point it was the first time when it was enough to pay necessary living expenses and make minimal debt payments) with a long-term networth value of about -$80,000 (Yes, that’s a negative number). Now, we are at about a long-term networth value of about $76,000 on an after tax basis with annual income only ranging between $45,000 and $60,000 for these years and having a household size of 7.

How was I able to do this? Simple. Since we already been living on such low standards of living (well into poverty level) without the help of the welfare system (cause of the fact the welfare system deny those that attempt to help themselves out in practice on account of the rules), and I certainly didn’t want to live in such poverty conditions as I did through much of the 1990′s from the time when I was first having to support my ownself with what little income I had and very little financial support from anyone else, I made it a point to take full advantage of the retirement system as soon as I fiscally could (which wasn’t until December 2001), but at the same time, I was to work on the debt situation and get that knocked down as quickly as I could which again, knowing how numbers works, I applied the ATBEAPR method primarily of determining how to get the debt knocked down.

Yes, I took on significantly large risk doing this, but I knew that prior to implementing the plan, but yet, I also knew I didn’t have much of a choice either given the financial situation I was in as a result of the debts built up from my college years including those debts built up as a result of insifficient income to live on while in college (was nearly put out on the streets as a result of this situation and yet, the state refused to help me with my necessary living expenses, even with me doing what I could do to help myself out). Oh well, that was the story of my first 30 years of my life, instead of getting sensible help as needed, got more things put up against me to make it that much harder for me to reach my goals. As such, I was forced to become so competitive to the point in college, I was accused by my own cross country running teammates I’m too competitive. Well so be it, but when you are constantly getting pushed back and told you can’t do things including things you are already doing, you will instead learn the system and all of the rules including the unwritten rules, stay within all of those rules and work the system to your best advantage and against others as a result of having been backed into a corner by others.

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avatar Meredith

William asked what would great the greatest positive reflection on your credit score; paying off closed accounts or not.

TJ advised him not to pay off old collections because they will drop off after 7 years. Is this true if debt collection companies continue to buy the debt from one another? Doesn’t the 7 years start over every time a new debt collection company buys your debt from another company?

I have good repayment history and settlements for the last two years but I have about 10,000 in collection debt from 05-07. I need to know what will make the greatest positive effect on my credit score in the quickest amount of time.

Should I settle these accounts at 50%, wait for the 5-6 year old debts to fall off in a year or two and settle the newer ones?, or make a payment agreement with all of the collection debtors and start the avalanche/snoball method with all of these payments?

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avatar TJ

Pay off the newest accounts with the highest interest rates. If you have stuff that is 5-6 years old forget them. Don’t agree to anything on those. I had one account (a Gas card) from years ago when I was younger and got in terrible debt and never paid. They still try and collect and send me notices and I ignore them. They switch companies often. It does not show up on my credit at all. It has not for years and years after the 7 year deadline. The catch is that if you agree to a payment plan with them or to settle the debt, then it will go back on your account because it is new and current activity.

Personally what I would do is get free debt counseling for your particular situation. You can turn your credit around fairly quickly. From what you’ve posted here I would pay off the newest accounts with the highest interest rates after trying to settle with them for a smaller amount.

The old accounts can be sold to any debit collector and they will call and send letters even after seven years, however they know that they have a very slim change of recovering anything. That has been my experience. Why is seven years the magic number? It dates back to historical and religious reasons. Debt was arbitrarily to be forgiven after seven years, and we have stuck tot hat rule, except for bankruptcy which I believe stays on for 10? Thankfully I have not gone through that.

However, there is always a way to repair credit relatively quickly and starting with the newer is the way to go, that way if you pay off the newer and then WANT to pay off the older stuff then do so. But if you pay off the older stuff and then something happens in a couple years, (health, unemployment issues, the whole list of things that can go wrong) then your new stuff will be there for years and your credit will be damaged if you can’t pay those. If you pay the newer off first, and then something happens, at least you will know that the older stuff fell off your credit record and you have at least improved credit.

So my advice it it were me, pay off the newest first. Student loans are different, those stay around forever and lead to garnishment, tax returns being withheld, all kinds of nasty stuff. But regular consumer credit cards are limited to seven years. So if I go get a Kohl’s card and charge it up to the hilt and don’t do anything to pay for seven years, it will fall off. My credit will be horrible, they COULD seek a judgement but don’t usually unless it’s for a ton, and they will at some point sell my account to a collector who will send me letters, call me, try to get me to agree to payments and so on. And if I then do so that info (my payments) will be reported to the credit companies and that info sticks for seven years.

Been through the bad credit days and done some things I had to do to survive school and family and still paying off school loans, but have no credit card debt and credit is no issue. Yet I still get a letter every now and again that I toss in the can. It was for about $900 of car repairs that I had to get and could not pay for in about 1994. In 2003 I bought my first house and credit agencies show no record of it. I have credit monitoring and it never shows. But If I agree to payments, it will. For seven more years from the date of my agreement.

So bottom line, be careful and don’t act with haste. Check into local consumer credit agencies that will give your credit counseling for free.

http://www.nfcc.org/

Above is a good link. Make sure you pick a NON-PROFIT agency, no scam stuff or payments needed. The above link actually offers online intakes.

That’s my two cents, good luck, if it’s any consolation zillions of people are in your same situation or close to it, or have been there in the past. The fact that you can even think about your credit issue indicates that you’re in a better spot than many today that are worried about a roof over their heads and food for their families.

And it ain’t getting better soon………

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avatar lladyon

Please assist me with this. I have a car loan, taken out in Feb of 2009. At the time I purchased the vehicle, I was in a negative equity with the car I traded in. As a result the loan amount was for approximately $49,294.13~ over 84months at a fixed rate of 2.62% for the first five years; thereafter it will be renegotiated in Feb of 2014. Presently, the balance is $33,027.82 with continuing biweekly payments of $296.74.
I also have a credit card debt of $5,000 @ 12.9%, just today changed over to a personal line of credit %7.5%. I believe the minimum monthly payment would be approximately $100.
I was thinking to pay the car loan off first, by the renegotiation date of Feb 2014. Do you think this would be the best plan? It will be difficult for me to meet the extra $500/mo I calculated I would need to pay to meet this plan.
What advice can you offer me? I have determined the car loan was the stupidest mistake I have thus far made and will never again do it in a negative equity situation.

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avatar TJ

Get rid of the smaller amount with the higher rate, and then go all out on the car loan.

If I was in your situation that would be my approach. The $5000 you owe should be gone quickly and you can then concentrate on the larger bill.

The only question I would have is what your rate on the car loan will be later. If it dramatically jumps then that might change things.

I suppose you’ve already thought about getting rid of the car somehow. I would try to get rid of it and buy the cheapest new car I could. By doing so you might improve the term or long term rate of your debt. Lots of car dealerships that are hurting that might be willing to deal.

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avatar Kristen

Hello,

I was wondering if anyone could give me their opinion on my financial situation. I do not have any credit card debt, I occasionally use my one credit card but typically pay it off in full every month. I only have maybe $200 on it currently.

My student loan debt is what I’m debating. I currently have 3 loans out (I’m unable to consolidate, one federal loan and one private loan in my name while one federal loan is in my fathers name that I’m just making payments on). The federal loan in my name has a principal balance of $21,125.93, fixed payment of $120.64 (graduated payment plan – standard was $254.22/month YIKES), with a fixed interest rate of 6.8%, set to be paid off in 2020 (9 years). I pay an even $200 per month on it. The private loan in my name has a principal balance of $23,162.65, fixed payment of $170.03, with a VARIABLE interest rate, currently at 3.25%, set to be paid off in 2025 (14 years). I also round up and pay an even $200 on it. The federal loan my dad took out for me has a principal balance of $10,088.70, fixed payment of $132.92, with a fixed interest rate of 7.9%, set to be paid off in 2020 (9 years). I pay an even $200 on this one as well, making my student loan payments per month $600.

I also have a car loan, outstanding balance of $8,749.88, fixed payment of $215.54, fixed interest rate of 5.4%, set to be paid off in 2015 (4 years). I pay an even $300 on my car loan, which I figure should maybe shave a year off.

My question is, should I keep rounding up on all my loans and evenly distributing a little extra to each? Or should I start with the highest interest rate first (my parents federal loan with is at 7.9% OR my private student loan rate which is VARIABLE and could fluctuate at any time). My plan was to pay off my car loan first (since its the most feasible and obtainable with paying it off quicker) and then put that $300 towards my parents loan they took out for me.

Oh, and I have a little bit over $1000 for emergencies in the bank and will be trying to be fattening up that cushion as well.

Opinions? Thoughts? Financial number crunches anyone involving the snow ball vs. avalanche? Thank you :)

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avatar TJ

Fatten up that cushion too. $1000.00 isn’t enough. Commit to $100 per month to that account and in less than a year you can double it. Try to save and pay down debt. Right now saving won’t be a great investment, the rates are awful on savings accounts. So putting that money to work by paying off debt is a good idea, but you need more emergency money. A trick I use is to round all my purchases up by a dollar. A $14.56 purchase gets logged in my accounting as $15.

Also, eliminate all late fees period. NEVER pay any late fees on bills. Pay them as you get them if you have the money.

Get on a budget by using microsoft spreadsheet. It’s easy, make a row for monthly income, another for monthly bills, and a formula that will give you a running total for the month. You can then track your spending and have your finances more up to date than the bank records. I account for every dime I spend on almost a daily basis. I am in my bank account online all the time and I caught fraudulent purchases before they were even cleared, only pending. You can also compare your bills to see if anything is out of range.

If you do this my guess is that you will find areas to cut and money that can be either saved or used for debt. Getting your savings up will ease some of the strain of being in debt. It gets a little easier when you have some cash on hand for emergencies.

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avatar TJ

I would put them in order of the highest rate to the lowest. Pay the minimum on all except for the highest rate, then pay as much as you can to the one with the highest rate. When it’s paid off, repeat the same process. You will save more in interest that way over the long run. By my quick calculations you have an extra $185 per month that you send to all the other loans that you don’t have to (not counting the one with the highest rate). If you round that up then it would be about $200 extra per month to send to your highest loan, so do that and in about 4 years you would have that highest loan nearly paid off and your car loan paid.

I would keep an eye on anything that is variable or that could change, but the guess now is that rates are going to be low for some time.

Another option is to put more money into the car loan. Student loans are a pain and everyone with any sort of education has them these days. They can be deferred and put into forbearance if times are difficult and they are not revolving credit accounts like credit cards.

Auto loans on the other hand are different and the car is gone if you don’t pay. I am of the opinion that you pay that off quickly because that loan is different. If you lose your job then you still owe the money. If your job is secure over the long haul then that might be different. That’s your assessment. Also how many miles do you put on the car, if you have a long commute they you will most likely not benefit much from paying a car off a year or two sooner, since you will be buying more frequently anyway.

Lots of factors to consider, bottom line money decision is that you pay less interest over the long term with the avalanche method most of the time. But other factors have to be looked at. Make your best assessment and plan, and then forget about it and live. No plan will be perfect. Maybe what you’re doing now is fine, what I would do might be different. Make changes if info comes up that warrants changes and evaluate your plan every so often. Sounds like you’re doing that already, But don’t get too caught up in plans about years down the road, or you will miss your life- what’s right in front of your nose.

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avatar martha jean knight

Could this method not lower your credit rating? The old cards with low to medium balances are the ones credit bureaus look for. If they are not used for 6 months, they could show up as cancelled or even delinquent. Check some other sites about improving credit rating.

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avatar TJ

No it would not hurt credit rating. You make the minimum payments on those cards or debts that have the lower interest and pay off the ones with the higher interest first. They would not show up as cancelled or delinquent unless they were, if they do then it’s a mistake.

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avatar Karl W

This is a great discussion. Thanks everyone for their input; this was one of the few intelligent discussions of various methods for prioritizing debt paydown that I found after some searching on Google. Most people just preach one system or another without really delving into the math to prove its superiority over any other system.

To me, the system that makes the most sense is computing the daily interest savings from paying down $1000 on a given loan, and prioritizing the loans that save you the most in interest per dollar of principle reduction.

For instance, we have the following debts:
$7400 at 6.5%auto loan payment 980/mo
$17000 at 3.88% auto loan payment 395.17
$17000 at 3% home equity loan payment 100
$602,000 at 3.5% payment $4300 home loan – interest tax deductible
$100,000 at 4% student loan $752/mo – interest not tax deductible as we make too much money

Basically I decided to pay off the auto loan today, which will free up $980/mo to pay more on the house, which we just refinanced from 30-year fixed at 4.75% to 15 yr fixed at 3.5%, which increased our payment $1000/mo to 4300 but doubled the principle reduction each year to $2200/mo from the current $900 or so. So essentially the extra 1000/mo from paying off the car all goes to principle on the house, which we hope will not plummet in value! Across the life of the loan we save over $300k by refinancing.

Given the tax-deductible nature of the interest on the home loan, it would probably make more sense to pay the student loan off before the home loan. But we really wanted to lock in a low rate on our biggest debt amount, and we had to go to a 15 yr loan to do that. We are also concerned that interest rates will climb and we will miss this opportunity to refi on favorable terms if we do not take it. So the student loan will have to wait a bit.

Oh well, it’s only money, right?

Thanks Again,
Karl

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avatar Karl W

Sorry that should have been principle reduction each MONTH of $2200 on the house – not year.

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avatar helen

An associate tried to convince me that the snowball method was superior to the avalanche method. He works for Primerica and they go around giving false information and fudging numbers so they can entice you to sign up for their high interest products. I tried to be polite at first but I finally called him out for giving out bad financial advice. He didn’t know I work as an accountant so he tried to get over.

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avatar Lindsay Downs

We unfortunately got behind on a lot of our credit card payments, and when we finally were able to start catching up, our credit card with the highest balance (and highest interest rate) offered to settle with us. We ended up cutting this major debt in half and will have it completely paid off within two months.

This will be a MAJOR MILESTONE and has given us great motivation to keep going. In fact, after getting the “hardest” debt paid off, all of our other, “smaller” ones won’t seem as difficult at all.

Thanks for reminding us that there is more than one way to get out of debt, but the best way is the ONE THAT YOU WILL ACTUALLY USE.

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avatar JustTryinToHelp

Wow. I am shocked about the bad advice given to people about the most effective way to pay down multiple loans. For fun I just surfed the web and checked the advice of various experts and they were all wrong. Some say pay smallest debt first and some say highest interest rate and some say other crazy thingies. I will easily demonstrate to the reader the incorrectness of the two mentioned and then tell you how to get closer to the optimal pay down strategy.

First we must agree on what we are after. After all is said and done we want to have paid the banks less and thus keep more money in our pocket.

Here is a scenario:
Two loans:
$180,000 with 3.25% interest and 15 year term
$13,000 with 5% interest and 4 year term.

Let’s say that I have $13000 extra cash in my pocket on the start of the loans.
Following the experts advice I should just pay off the $13000 loan
(it is smaller and higher interest). This will save me all the interest on the smaller
loan which is $1370. However, if I put the $13000 toward the large low-interest loan
I pay $7662 dollars less in interest. That is about 5 and 1/2 times more money in my pocket.
It does take longer to get your money but in the end you get more. Now this was a simple
scenario but a similar demonstration is possible with a small monthly extra cash payment.

Now, I am not saying you should pay the larger loan first. If you want to figure
out how to give less money to the banks then you need to consider 1)loan amount 2)interest rate and 3) term of loan. Then go to bankrates amortization calculator and run the different
payoff schemes. They allow you to put in single extra pay off (like above), monthly
extra payoffs and yearly extra payoff. Go to the bottom of the amortization schedule and
check the amount of interest you have given the bank for each scenario. Doing this might require some real thinking as you may need to start a extra payment per month in the
middle of a term. Just record the numbers on that date and start a new amortization schedule
for the current principal and remaining term. I know you can figure that out.

You simply want to minimize the interest you pay on all the loans combined. It is actually not an easy calculation to achieve the most optimized payoff but you can get somewhat close using the calculator and running simple scenarios.

If there are tax implications from one or more of the loans you need to run the numbers completely. Most financial experts could not figure out the absolute best scheme to save their lives. So don’t beat yourself up. Mortgage calculators just are not setup to do the exact calculation you want.

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avatar TJ

Nice point, I don’t think anyone here is advocating for the avalanche method as the way to go without any alternatives. Each case will be a different one. Really the best strategy is to determine what to do about “needs” and “wants” in the first place.

Being able to distinguish between the two will ease many of the debt burdens that people have. Housing, education, and so on are necessities, but overpaying for them = wants due to status and so on. I could have gone to USC and tried to live in West LA, instead I went to a cheaper school and lived in a cheaper area and still have debt but not nearly as bad as it could have been. I would love to buy a boat, travel and so on, but I will do so when my debt is paid. The mindset is really the key thing, after that the tools chosen can be more or less benefical based on the situation, but if the mindset isn’t there then the tool is of no circumstance.

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avatar Josh W

I don’t believe what you said to be wholly accurate. Let’s take your example and assume you make annual payments at the end of each year. I realize it would probably be compounded and payments made monthly, but this will be easier to compute.

On $180,000 at 3.25% for 15 years your annual payment would be $15,351.94
On $13,000 at 5% for 4 years your annual payment would be $3,491.58

Scenario 1: Pay $13k at t=0 towards $180k loan
Your starting balances would therefore be $167k and $13k while still making annual payments of $15,351.94 and $3,491.58

With this method you would pay off the small loan after 4 years and apply that payment to the larger loan. The larger loan would be paid of in year 12 with a final payment of $9,938.56.

Scenario 2: Pay $13k towards smaller loan with higher rate
Your starting balances would be $180k and $0k allowing you to make annual payments towards to large loan of $15,351.94 + $3,491.58 = $19,018.10.

With this method you would pay off the larger loan in year 12 with a final payment of $9,161.81.

Summary: It’s still cheaper in the end to pay towards the highest rate loan.

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avatar Gabrielle

A few years ago I found myself in 27,000 CC debt. I saw the Ramsey snow ball method and liked it, so I tried it out. It worked well, paid down one of my 3 CC’s quick! Then I got a letter from the CC company with the highest balance. Seems like they were not happy simply receiving the minimum payment, and they considered me a “risk” so they bumped my interest rate from 9% to 18%. WOW! I was shocked! So needless to say, I started my own way to pay down my debt. Transfer method! What I did was transfer all my debt to the lowest interest card that was 5%. Then a few months later, I started hunting down 0% intererest cards. When I found one that had at least a term of 12 Months, I’d transfer out a portionof the 5% card to the new 0% card that I could pay off in 12 months. Then when that was paid, I’d hunt again, and transfer out another portion I could pay off during the 0% promotional period offered.

Now with this method you definitely must make sure that you make your payments on time, and be sure that you can pay off any amount you transfer during the 0% promotional period. Also, take into consideration the fee for transfer, which usually is around 3% of the balance. I have been doing this for a few years and I am proud to say that I am down to my last 3 payments (balance of $2900 at 0% interest), and have managed to save 10,000 in a liquid savings fund. I hit these payments with $1000 a month :)

It took lots of discipline, so if it is important to you, look through all of your bills and see what you can cut out. I have a basic home land line (just a dial tone and basic internet), no cable (have netflix & hulu), basic cell phone with texting (no web or data), use coupons avidly, eat out rarely, and but clothing on clearance or shop at thrifts. I also do some hobby work on the side that covers my gas expenses and kids lunches for school. This has worked for me and my family, and being single mom, I think I have done pretty darn well! The sacrifice has paid off. Beware of that Ramsey Debt Snowball… you might get one slammed right in your face like I did!

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avatar Kathy

I have 5 cards and the interest rates are all the same, 15%, except one that’s 7%. I decided to leave the 7% one for last. It was hard choosing which of the other 4 to attack, but I finally picked my Costco card for the reason that it gives me 1% on purchases and 3% on gas. I see it as reducing that 15% to 14% on the amount I’ve paid down, and freeing up more money for the next payment. Also, if something happens, I’ve paid down the card that much that I can always go there for food and gas while attempting this debt avalanche, because I have credit there.

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avatar Jeremy

Are there any studies comparing snowball vs avalanche ?

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avatar Josh

I understand the quality and logic behind high interest first, but I think I have a different situatuion. I have 2 student loans, a signiture loan, a Discount tire card, and a Lowe’s credit card. I have the money to pay off the student loans and the Discount Tire card, or the signature loan by itself, or just half of the Lowe’s card. Lowe’s has the highest interest, then the signature loan, then the student loans at just 2.3%, and deferred interest on the Discount card until sometime next year.

My question is, is it better to pay off more things that will improve my credit rating and use the those payments towards the bigger balance/interest rates, or just pay half of the higher interest where only 1 or no loans are payed off and I’ll still have all those payments to make?

It makes more sense to me to pay off the little things for a better credit rating now, and then attack the larger high interest with bigger payments. Im ready to make a move, but I need an opinion or two and some motivation. Please Help!!!

Josh

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avatar Karl W

Forget the credit rating. When you get your stuff paid off your credit rating will be great. So focus on getting stuff paid off, period.

Figure out which of those loans is costing you the most interest each day, and pay it off. As the principal balance declines, the amount of interest you pay on that balance each day declines (even if the interest rate is higher than the rate on some other loan you have), so you may get to the point where the amount of interest paid daily on the loan becomes less than the amount of interest you are paying daily on some other loan. At that point you can switch to paying off the more expensive loan, or just keep paying off the rest of the first one (there shouldn’t be much balance left) and then switch.

Repeat ad nauseam. Good luck!

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avatar Bill from NJ

I was asked by a friend to help determine which of his 9 student loans to send additional principle. We are both Dave Ramsey FPU graduates. The challenge was that each loan has a different balance, rate & several different terms. They are literally all over the place.

Financially speaking, applying all extra cash to loan with the highest rate was by far the best choice. One loan sticks out like a proverbial sore thumb. The interest rate was almost double the others and the balance was the third highest. It’s a “no brainer” as the first loan to attack. My amortization schedule supports this statement.

However, if I use only interest rate to determine the next loan, I’d pick the $8k loan at 4.25% over the $16k loan at 4%. This would not be the best financial decision. Therefore, unless I’m missing something, at some point, the loan with the highest balance should also factor into the decision of which loan to attack.

I was wondering if there’s a better way to mathematically determine the priority of loan prepayments other than modeling amortization schedules for each (ex. highest product of rate times balance). Thanks

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avatar Josh W

Attacking the 4.25% loan before the 4% loan would in fact be the best financial decision. In all situations, as long as you’re making at least the minimum payment on all loans you should throw excess cash towards the highest rate loan. This is purely mathematics.

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avatar TJ

Well, I’ve been following the avalanche method since July of 2010 and I only owe the following as a result:

a $32,000 student loan at 7.8% that was at $105,000 when I started in July of 2010, this remains the top priority payment in that the % is the highest of everything I owe

absolutely NO CREDIT CARD DEBT, all credit cards are paid monthly

My wife’s student loans of over $100,000 at various rates, some as low as 2% up to 5.75%, those are in forbearance and will take over the top spot when the above loan is paid off this year (2013)

I owe one car payment at 0% interest at about 17,000 390 a month for 4 more years

A house payment fixed for 30 years at 5% interest that will be the focus after the student loans are paid off.

That’s “it”

The tempting part is to pay off the car loan, but that seems like no gain at all, the same amount of money will be paid our regardless of whether the loan is paid in full in a year or two or four years, but I hate making the payments every month, I would like maybe a looser budget each month.

I would also like to start paying on the other student loan and perhaps the house, but they both have lower rates than the $32,000 loan. However they both generate more interest each year. It’s tempting to pay the other student loan down some even though the rate is lower.

However, let’s say I pay 36,000 towards debt this year. Most of it would be to pay down debt that’s at the 7.8 rate instead of a lower rate, so I think I’m going to stay on track and pay off the lower loan with the higher rate.

This time next year I will owe a large student loan, a zero interest car note, and a house with a reasonable rate (you could suggest I refi to a lower rate on the house, thought of that, can’t yet because I lost a rental house to foreclosure so I have to wait a couple years, no worry rates will still be low then too).

Any other ideas? I am paying out $3,000 towards the highest loan, the minimum on the car note and the house of course, and forbearing the student loan till next year when that one will then get the extra 3k. If I can keep this up until January of 2014 I would have paid off a $105,000 student loan in about 40 months with about that many months to go before just owing on the house.

My eventual goal is to owe on nothing monthly except the house and then decide whether to move or begin making larger payments towards the house. That would be the time to start planning retirement strategies.

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avatar Anonymous

Cut up your credit cards !

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avatar TJ

I would like to but I still put a balance on them to pay off each month. They keep my credit current and in good standing. I’ve been through credit card hell once already early in life, so I won’t make the same mistake again. I never pay any interest because the full balance is paid off each month. I make money off one of them by getting cash back at the end of the year. I also like having them as an extra back up to the emergency fund.

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avatar Maria Barker

I tire of the only explanation of the Debt Snowball being psychological. Yes, I understand compound interest, and how financial decisions should only be logic/mathematically based. Truly I do. However, when one’s bills are LARGER than one’s income, the effect of paying off the smaller debt, and thus that ENTIRE payment, is NOT merely psychological, it is, in fact logical. Get rid of all the payments you can, and you are no longer forced to go deeper into debt each month just to meet your obligations. Why is this factor never a consideration, that we are not just in pursuit of a psychological ‘boost’, but in pursuit of an outlay that will actually work with an input? Both the proponents of the snowball, and the proponents of the avalanche, only mention “psychological” not actual benefits of getting rid of payments as quickly as I can.

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avatar Luke Landes ♦127,372 (Platinum)

There is only one way to get out of debt the quickest, and that’s by prioritizing debt by interest rate, highest to lowest, paying the minimum due to each of the debts, with all extra cash available going to the highest prioritized debt until it’s gone. If you want to talk logic or mathematics, that’s the only answer. Getting rid of a small debt faster does not help your overall debt as much as continuing to pay the highest-interest debt. If the smallest debt account is not also your most expensive debt, and you’re prioritizing that less expensive debt because it’s smaller, it’s slowing you down and costing you more money. There’s no logic to that, and that’s why Debt Snowball advocates do not focus on “logic,” instead they play to emotions — often the same aspect of the brain that gets people in debt in the first place… and continuing to focus on emotions makes it more likely that they’ll give into their emotions later and fall back into debt.

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avatar TJ

I agree, the psychological is nice, but just because something seems logical does not mean that it is. People should struggle with the best way to manage their debt (seems like most don’t seem to care at all?? See student loan defaults, etc).

Doing not what feels better but what actually saves money is what makes decisions business decisions.

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avatar Maria Barker

What I said was, that I had started with more in payments to make than I had money to make them, therefore having to borrow more each month. Surely the first step in eliminating debt is to stop borrowing!?! The avalanche works well when you can make your all your payments. The snowball and snow flake methods work too when you can make all your payments, but not as well as the avalanche does. I clearly stated I could not make all my payments, so there was an actual benefit, not a psychological benefit, to using the snowball method to eliminate entire payments, so I could stop borrowing. Clearly neither of you read what I actually said, and have responded to what you think I said.

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avatar Luke Landes ♦127,372 (Platinum)

If you can’t make all of your minimum payments and are going further into debt each month, it doesn’t matter which method you use to paying off your debt, because you’re taking a step back every month. Being able to make your minimum payments is a prerequisite for applying the Snowball method, Avalanche method, or anything else. Keep your expenses down, get your income up, negotiate with your creditors to get your minimums within manageability, then apply the Avalanche method. In the mean time, pay at least the minimum to as many cards as possible to avoid additional fees, which are often worse than interest.

avatar TJ

A bit of an update, right now here are my “only” debts:

A $26,500 student loan at 7.8%, paid so far ahead that I don’t owe payments for 4 years

A $16,500 Car Loan at 0% interest that I pay $390 a month on for another 3.5 years

A $85,000 student loan (wife’s) at 5.75% (not paying in forbearance)

A $20,000 Student loan (wife’s) at about 4% (not paying in forbearance)

A $227,000 Mortgage Fixed for 30 at 5% (about 3 years into it)

Current plan has been to pay the mortgage and car payment minimum, forbear the lowest interest rate student loans, and kick the rest to the student loan with the 7.8 Rate.

Well, I teach college at nights to make extra and enrollment is declining, so classes may be cut, which would reduce my “extra” from $3,000 per month to $2,000, so 1/3 less towards paying my highest student loan. The good part is there are other opportunities, but I am reevaluating my plan based on having less per month to go to debt.

Should it matter at all (the reduction). Psychologically I have toyed with many ideas such as:

1.) Paying cash to the car loan to increase the amount available per month by $390, to be used towards debt or other needs, making sure that the $2000 available does not drop more. However there is NO SAVINGS here at all other than adding more to the monthly budget, potentially creating room for waste. I’m thinking it would be better the leave the money in savings and draw it out only if I have to.

2.) Switching my payments to the loans with the higher balances and therefore the higher interest per year. However when I did this I ran a scenario in which I paid $25,000 at 7.8 versus $25,000 at say 5% and it was obvious that paying the same amount towards a higher rate saves money, regardless of how high the principal is. However in my plan I am not paying towards some of the loans because I don’t have to, I can let them rise in the short term and pay off the higher rate quicker.

So in looking at my plan, what do you all think? I am thinking to stay on the current plan, but the time frames may become extended a bit. However, hopefully the current rut won’t last forever and I will be back teaching shortly, there may be another class that I can roll into instead of the one that will be cancelled. I also have another opportunity.

I think when you develop a plan and have stuck with it and grown used to it for a significant period of time it becomes the norm, and when changes happen it makes you reevaluate and run through all the same issues that you did to begin with. However I think the strategy I have is still a sound one despite the reduction in money that I can put toward the debt.

I suppose whining that I only have 2000 to put toward debt a month instead of 3000 is pretty lame given the economy we deal with these days. It could fall easily to zero with a job loss, illness, injury., etc.

If anyone has other ideas then I welcome them. Still want to get rid of that car loan even though the savings is zero. Having the extra $390 a month would be nice! I hope that more people post and talk me out of doing that. Although leaving it in the bank is drawing me a whopping .85 % !!

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avatar TJ

Well after all that I ended up with more work than I bargained for. I think another problem that we face (a good one in a way) is having TOO MUCH work and trying to pay things off too quickly. Sounds like one of those good problems, but nonetheless it’s important to enjoy life too and not get too consumed with debt. Far better to pay debt off gradually on cruise control rather than too tight a budget. That being said I decided to continue my plan and not pay off the car loan, continue to make the payments of course and continue to knock out the student loans.

At some point my goal is to be left with only the house payment every month and then if I have to buy an auto it will be at the lowest rate possible with an early payoff. That is a realistic plan to be achieved within the next 5 years.

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avatar TJF

Well Here’s my update using the Avalanche Method:

No Credit Card Debt
No Car Loan
My Student Loan is now at $2000 and will be paid off before the end of the year
Wife has student loans of about $100,000 total
Mortgage is $224,600 fixed at 5% 30 year
That’s it
Next up on the chopping block is my wife’s student loans, no car purchases until those are paid off within the next 4 years.
Incredibly freeing when plans work. Difficult to stay on task knowing that you can pay down other debts that have lower rates to “feel better”
However what has worked for me is to take the amount I am paying, say 2000, then ask myself whether I would rather owe 2000 at 8% or 5% and that refocuses me. Yes it would FEEL better to pay down debts that are bigger, but once the lower loan is gone it is gone forever. That’s motivating.

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avatar Josh W

Thank you for writing this! I’ve had arguments with many people over the years where I tried to explain paying on loans with the highest interest rates would allow you to escape debt the fastest. Dave Ramsey and others have managed to confuse most people into believing the snowball method is fastest and most efficient method.

To me, I just don’t understand the emotional part of paying bills. I’m a very mathematical person and emotion plays no part in how I pay my bills. I pay them in the order that will get me out of debt the quickest. Emotional people should just look at the lump sum of all of their bills rather than individually, then the snowball method would seem less appealing.

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avatar Jim

I have several types of debt, 1.) regular household bills that are a month or so behind. 2.) Debts with interest: 6 or 8 from 200 to several thousand dollars. I hust got a job making 600 to 800 more a month. Do I concentrate on paying the minimum on house bills and concentrate on the smaller loans to have more and more money each month or catch up the house bills first and see if there is anything left?

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avatar Trixielikafox

I can see good points on both sides, but why does it have to be one or the other? Why not kill debt from both sides? Start by getting rid of your smallest debt by doing a couple extra payments to the principle or using a lump sum such as your tax return to pay it off. Take the payment you were making for that and add it to the highest interest ticket. Then do it again with your next lowest principle take “extra money” that you accumulate such as change from a transaction, or forgo the coffee you buy and make it instead and use that savings toward the lower principle. Then once again when that one is paid off put it’s monthly payment toward the highest interest. You get the satisfaction of paying off a debt completely and reduce the time spent on paying the higher interest. That is just one of a few ways I saw the two can be combined. But I have to say neither take into account that emergencies come along and that for either of these to be truly effective basic budgeting skills are necessary. The real important thing here is that we are deciding to be more financially conscience and responsible so what if we pay a little more in the long run at least we are paying less than if we were only paying the minimum payment or worse defaulting. I am grateful for all of the advice and another resource to refer to. But I think it is arrogant to say that your method is the best, because realistically you could say that several things are better such as don’t get into debt in the first place, or get a better job that pays more and spend less, learn to live on less than you earn. Yes I know these are all ideals and easier said than done, but that is exactly what I am trying to illustrate for some people your way of paying off debt is easier said then done and is circumstantial. With that being said I found the comments both educational and entertaining.

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avatar TJF

By math standards the avalanche is the best, you will save more in the long run. Some people say, and I agree, that one way to make money is to save money. You should have a descent amount saved (and people vary as to how much that should be) and then attack debt according to this method, You will make money by saving on the interest you are not paying after the debt is wiped out earlier than scheduled.

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avatar JM

“Start by getting rid of your smallest debt by doing a couple extra payments to the principle or using a lump sum such as your tax return to pay it off.”

Yep. This move can be very freeing in an immediate, everyday sense. “Bird in the hand” philosophy can really come into play when there’s not a lot of cash. Ideally you should be applying any extra cash to the highest interest loan and keeping your monthly debt payment the same, but knowing that you don’t HAVE to, and that extra real cash has been freed up, can provide some security on a tight budget.

Long term the avalanche mathematics are sound, but life doesn’t happen strictly on a long-term balance sheet and for some of us what contingencies the next day or month might bring is a very practical concern. So maybe most, or half, of that extra cash will go above the minimum payment on the highest interest loan and the rest will be saved or deployed elsewhere. You have to balance the immediate and concrete with the long term and abstract based on your particular situation. If debt is the highest priority life concern, then full speed avalanche all the way.

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avatar grinch

This advice is mathematically wrong. If you want to be effiicient, you MUST factor in the TERM of the loan. Since interest rate is ANNUAL, 5% over a 5 year loan is much better than 5% over a 10 year loan. If you do the math, you will find that 10% at 5 years term is almost identical in total interest paid to 5% at 10 years. The mathematically correct way is to multiply the interest rate by the term, and choose the debt with the highest result.

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avatar Luke Landes ♦127,372 (Platinum)

That’s incorrect. Loan interest rates are given as an annualized number. A 10 year loan with 5% APR has the same rate as a 5 year loan with 5% APR. APR stands for “annual percentage rate.” I’m not sure where you got that information, grinch. You’re always better off, given the choice, of accelerating the payoff of a 5-year 10% APR loan over the payoff of a 10-year 5% APR loan.

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avatar Andy

I’m glad I stumbled upon this article. This was my burning question. While there are merits to both the snowball and the avalanche, the avalanche actually requires less discipline. I’m trying to help my girlfriend reduce her debt. She is somewhat fiscally irresponsible. The problem with the snowball method I see for her is that when she pays off a balance she is more likely to spend that ‘extra’ money than use it towards her debt. If we can pay down her high interest rate ones first while making the minimum payment on the others some of her low interest rates will be paid outright before the high interest rate ones thus killing two birds with one stone.

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