Recent Divine Discussions

Wednesday, September 12, 2007

What is the best way to snowball your debt?

I have been pondering this question for the last couple of days. I did some research online and I am debating on what exactly is the best way I should snowball my debt.

The majority says to pay off your debts in interest order: paying the credit cards with the highest interest first. Paying the cards with the highest interests first reduces the debts that grow the fastest due to the interest added every month. This way helps you save a lot in interest over the period of the snowball.

Other folks, like Dave Ramsey, suggest arranging your debt by balance and paying off the card with the smallest balance first. I think this is the best way for me to go. My logic is this: Paying off my debt in balance order starting with my smallest balance will free up funds from my minimum payments and allow me to apply more towards my debt each time. Factoring the bonuses and tax refund I will use towards my cc debt will make an even bigger dent.

I checked out the popular Snowball Debt Calculator and tried out both scenarios to get an idea of how much of a difference there is between the two

I currently have 11 credit cards with balances. My total minimum payment is $322 and I have budgeted an extra $205 to apply on top of that.

--> Here are my results when snowballing higher interest first:

It will take you 29 months to pay off these debts if you snowball correctly. During that time, you'll pay $2,298.00 in interest.

If you paid the same amount per month, but changed the order in which you paid your debts so you weren't paying the highest interest rates first, it would cost you an additional $753.00 in interest.

--> Here are my results when snowballing smaller balances first:

It will take you 30 months to pay off these debts if you snowball correctly. During that time, you'll pay $2,442.00 in interest.

If you paid the same amount per month, but changed the order in which you paid your debts so you weren't paying the highest interest rates first, it would cost you an additional $609.00 in interest.

As you can see there isn't that much of a difference. The analysis shows that the best choice is to payoff debt by interest rate order but thats only by paying it off 1 month earlier and $144 less in interest. The calculator doesn't take into account the bonuses and tax refund I plan on applying to my cc debt. Nor does it take in account the fact that my current $522 available towards debt repayment will increase as I get further into my repayment. Taking these factors in account, how much of a difference between the two scenarios will there then be?

I can create an excel sheet with formulas similar to that on the Snowball website yet specific to my situation. I may do that this weekend if I have time and compare the two choices then. But for now I am leaning more towards snowballing my debt by balance order. You can't beat the plus of wiping out at least one credit card a month and seeing that zero balance each time.

How do you plan on snowballing your debt? Credit card debt?


Mya Moola said...

I'm going by interest rate, seeing as how a few of my cards have some truly atrocious rates. I've heard a few folks say there's a huge satisfaction level from paying off one card, but I'm so motivated, I'm good to go I think.

One thing about your entry that struck me a little was the reference to $144 in interest being "not that much of a difference." One HUGE realization I've come to as I start examining my PF is that I've had a much too cavalier attitude toward my finances over the years. For example, not being concerned with what interest rate my savings account earns because it's only $XX over the course of a year.

I'm trying to recondition myself to really put a value on every dollar that comes in and out of my life. So even if I only save X amount of dollars by paying interest first, it's worth it to reclaim money that should be mine and not the credit card company's.

ok, hope that wasn't too preachy :)

Dimples said...

@ Mya

You weren't too preachy. Keep it real with me. That's the way I like it. What I meant by $144 not being that much of a difference is this: Based off a semi-accurate calculation, I don't think $144 is much a difference to sell me completely on paying your credit cards by interest order. I would see it differently if the difference were to be $1144 because then, anyway you cut it, the amount would be to significant to just chalk it up to a skewed calculation. I plan to recreate the debt snowball formulas in a database or excel sheet, revise them to fit my situation, and compare the two scenarios again. I'll use the results to make a final decision. I'll be sure to keep you updated.

dream said...

I prefer to pay off the smallest balances first for the same reason you mentioned -- one less minimum payment to send thus freeing up more money to snowball the next creditor. This is especially true when you have huge differences b/t balances -- say a 3k debt vs. a $500 debt. It makes more sense to me to knock out that $500 then concentrate on the 3k. If I owed about the same balance on each card, I'd do interest rate order.

Dream said...

Ok so I just tried that calculator. I included my stud loans as well and it said that I will pay off my debts at the same time with either method but would save $92 in interest if I do interest first.

I just had another thought though. If you pay off the smaller balances first, if you were to fall on hard times and could only pay the minimum to your creditors, you'd have less people to pay and more money in your pocket at that time. That's another reason that I'll be doing balances first.

Mya Moola said...

@dreams: Using either interest or balance snowballing method, you kind of don’t “free up” any money. The idea is that you’re allotting a certain set amount toward your debt, say $500/month. How you distribute that $500 is a matter of personal preference, i.e., if you just want to attack the highest interest first, or get some motivation through the satisfaction of paying off a smaller card first.

In either scenario, if you genuinely fell on hard times, you’d just have to cut back on the “extra” money you were putting toward debt. In theory, if you’d been paying on that high interest debt all along, the minimum would have gone down.

To me, debt reduction is seriously a personal preferences kinda thing, you have to take into account what the experts say, but you have to do what works for you also. Paying off high interest is all well and good, but if the “little victories” will give you more motivation, then that’s the route to take.

As my mama would say, “I don’t care how you do it, just do it!”

(usually in reference to us deciding whose turn it was to clean the kitchen when we were younger lol)

dream said...

@ Mya - If you fell on hard times, you'd have to at least pay the minimum to all of your creditors. If you get rid of the smaller ones first, that = less minimum payments which = less money out of your pocket at a time when you need your cash the most. I surely would suspend the snowball until I got back on my feet if I were in that situation.

It really does just depend on your situation and preferences. For me, it just wouldn't make sense to hold on to a $500 debt to focus on a 3k debt.

Single Ma said...

I don't know if this would make sense with credit card debt, but I paid off debt in order of monthly payment. I attacked the highest monthly payment first. This way, I was able to reduce the principal faster and free up the most money once it was gone.

I had to read this post 3x before I commented. My brain froze when I saw this:

"I currently have 11 credit cards with balances."

Wow! For pure psychological reasons to feel a sense of accomplishment, I'd pay off the smallest balance first to reduce that number.