What order to pay things off
Ξ February 4th, 2008 | → | ∇ Debt Payments |
I’ve been doing a lot of thinking about which debts to pay first and which ones to keep paying the minimums. For the most part, there doesn’t seem to be a right answer so far.
Of course, Dave Ramsey says to pay the smallest balance first. The logic is that this will give you some good, positive results early on so that you will see results and it will give you a psychological boost. This gives positive reinforcement so that you are more likely to continue to make cuts and increase your debt snowball payments. As a general rule to be given to such a wide audience as he has, this is good advice. It is something that is easy to grasp and it answers the question, “I want to pay this off, but where do I even begin?”
But of course it may not be the best for everyone. There are some people who are very inclined towards the mathematics of it all and will insist on paying off the higher interest first. By eliminating the highest interest, you can pay off your debts in the shortest period of time, all things being equal. You may even pay them all off a month or two faster this way.
But there is a problem with both of these ideas. With the lowest balance method, what would happen when you get toward the end? That is to say, what happens when you have your last debts remaining and they are all high balance debts? It seems to me (and I am no expert on these things) that as time goes on, there will be a time when you will face burnout. To maintain a frugal budget even while working overtime and delivering pizzas on the side, while seeing no benefit in your personal life is a good recipe for burning yourself out. It seems that there could come a time when you have simply reached your limit of what you can endure. Especially if you are facing your highest balance debts. I would think that by paying down your highest limits when you are most excited about paying your debts off and especially motivated to do the work and sacrifice necessary, you can preserve your easy targets for when things get less motivating.
Then when you are facing burnout, you can start paying off some of the smallest debts and that will make you more motivated at that time, when you most need it.
And again, if you are paying the highest interest debts first, you will come to a time when you are finished paying off the worst ones and are left with a bunch of zero interest debts. I can all but guarantee you that if you are so number-oriented as to start with the highest interest debts that when you are down to zero interest debts only, you will think that it would be better to put that money in savings and draw interest on it until the zero interest period expires. And while mathematically this would make a lot of sense, psychologically it would not. When you pay off the zero interest debts and become debt free, that will make you even more excited, even if you are a numbers person. Or so it seems to me.
And of course there is a third possibility. You could pay off the debt that you hate the most. The one that kept calling you and asking if you wanted credit protection. The one who wouldn’t adjust your payment due date to what worked better for your schedule. The one who was rude to you on the telephone. And of course, the one that raised your interest rate to 21.9% 18% interest. That’s the one that I am most inclined to.
However, over the weekend, I’ve been thinking a lot about it, and it occurred to me that there is no 100% right answer. You have to do what works best for you. And with this income tax refund coming my way this year, I want to know before it gets here where it will be going. So I’ve been working out different payoff plans for my debts.
I started by saying, “What if I paid off the BofA account with it, and took what’s left and put it towards the next CC in the stack. If I were to transfer the balance of the Air Conditioner to the BofA account after it’s paid off, I would be able to pay off all of the CC’s that would be left with any sort of interest on them by the end of summer.
And I tried variations of this, too. What if I just paid the next CC with the Income Tax Refund and then made payments on the BofA until it’s paid off by way of the debt-snowball. The time works out the same, except that I would be paying more interest on the Air Conditioner. So that’s a no-go.
And then it occurred to me. I could put the Income Tax onto the student loans.
As it stands, Sallie Mae is getting right at $850 a month from me, and will be paid off at or about the end of October.
But if I simply put the Income Tax onto the student loans and then made my normal payments, it would be gone at the end of May.
But then I thought, what if I left BofA alone for a little while and put the debt snowball onto the student loans? They would be gone much faster. AT THE END OF MARCH.
Now of course, I would still have an interest payment on the BofA account because of this. But because I’ve transferred a lot of it to zero interest cards, I could handle it for a couple of months. Because after the student loans are gone, my debt snowball would grow by a whopping $850 a month, putting it up near $2500 per month. This means that I could pay off BofA in April, and because of the third paycheck that I will get in May, I could actually pay off the Air Conditioner in one month, or at the latest, the first paycheck of June. Factoring in the zero percent CC’s that I’ve picked up, minus the AC and the BofA, I would drop about another $90 or so a month after that into the debt snowball, putting me up well past $2500 a month extra to pay off the remaining debts. At that rate, not one of them would last more than two months, with the exception of the car, which I intend to leave for last anyway.
Right now, this seems like the best all-around plan for me. I’ve been dancing with Sallie Mae for too many years now. And although I’m hating BofA, I could handle three more payments. And actually, when I put in the transfer to the zero percent, this months payment had already posted as due, so the transfer actually satisfied my payment to BofA for February. That makes it easy to pay back the Emergency Fund with the money that I’ve already budgeted to this month’s BofA payment.
So somebody let me know if they see an obvious hole in this plan. I think that the benefit of knocking out the student loans is great enough to justify making the extra interest payments for a few months, because then my monthly obligation is lower and if work should slow down again, it would be a lot easier to hit my break-even point every payday.
But maybe I’m overlooking something. I am still learning, after all, and tend to make this all up as I go along.
So feel free to put your two cents in. Good, Bad, or Ugly, it doesn’t matter.
on February 5th, 2008 at 6:34 am
Whatever is at zero interest, could be disregarded until Sallie and BoA are knocked out. However, on the accounts you are paying interest on, I say knock out smallest to largest asap.
Since you are making lots of small payments, payments that are going partially to interest, these are costing you the most. By knocking out the smallest first, you get more money freed up to hit the larger debts. Less hassle as well!
My 2 cents.
on February 5th, 2008 at 11:26 am
That’s one reason why I was wanting to hit Sallie first. Because it is an installment loan, the minimum payment doesn’t decrease with the balance, so paying on it has no benefit to my monthly snowball until it is actually paid off. And while I could knock out a couple of smaller ones with the same money, the benefit of knocking out Sallie is that the monthly payment is so high that it will affect my snowball the greatest.
I’m paying about two cents per dollar balance in monthly payments for all of my other debts, but Sallie is getting a whopping eleven cents per dollar balance, and gets higher the more I pay on it.
So I was thinking of paying Sallie first, and then paying all of the revolving accounts that have interest from smallest to largest, more or less, after she is gone at the end of next month.
Does that make any sense at all?
on February 5th, 2008 at 2:54 pm
I don’t have any good advice. I fiddle a lot too; I usually chose the debt I hate the most regardless of how smart it is.
I play with a snowball calc a lot. Moving stuff around in certain orders or whatnot lets me see in b/w the total interest and over how many months.
Give it a try: http://www.whatsthecost.com/snowball.aspx
on February 6th, 2008 at 10:39 am
I really enjoyed this post Jag. I have played around with my debt repayments so I can’t tell you which method is best.
I started off paying the smallest balance debt first but when that was at zero I switched to the highest interest one.
Both systems were equally rewarding for me and I now have both the smallest debt AND the highest interest debt totally paid off.
I am working on trying to see which method I will use now to pay off the rest of the other debts which are all around the same amount and the same interest rates.
It really is a personal decision as to what works best for your situation…so all the best.