Debt Tsunamis, Debt Snowballs, and Why the Conventional Wisdom About Defeating Debt is Wrong

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When you’re in debt, one of the toughest problems is knowing where to start. It’s not that you have just one debt. You have several. Or dozens. Which debt should you pay off first?

Let’s assume that Betsy is a typical young woman in her mid-twenties who awakes one morning to realize that she’s in debt and wants to do something about it. Betsy might be burdened with the following hypothetical liabilities:

  • $20,000 college loan at 5%
  • $8,000 credit card balance at 12%
  • $2,000 computer loan at 10%
  • $3,000 car loan at 4%
  • $5,000 loan from parents at 0%

Most financial advisers recommend that debts be repaid in a specific order: from highest interest rate to lowest interest rate. By paying off the high interest rate debt first, you’re minimizing the total you’ll eventually pay in interest.

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Following this advice, our hypothetical Betsy would attack her debts in the following order:

  • $8,000 credit card balance at 12%
  • $2,000 computer loan at 10%
  • $20,000 college loan at 5%
  • $3,000 car loan at 4%
  • $5,000 loan from parents at 0%

This payoff plan does, indeed, make the most financial sense — if you have the discipline to stick to it. But it often makes less sense from a psychological point of view.

I struggled with debt for over a decade. I tried several times to eliminate my debt using the highest-to-lowest method, and each time I failed. Why? Because my highest interest rate debt was also my debt with the highest balance! Psychologically, I felt defeated; I could pay on this debt for months at a time and never seem like I was making progress.

Eventually, I discovered an alternative. In his book The Total Money Makeover, Dave Ramsey advocates the debt snowball approach to debt elimination. Using the debt snowball method, you ignore interest rates when determining the order in which you’ll repay your debts. Instead, you organize them from smallest balance to largest balance.

Using Betsy’s debts as an example, she’d repay them in this order

  • $2,000 computer loan at 10%
  • $3,000 car loan at 4%
  • $5,000 loan from parents at 0%
  • $8,000 credit card balance at 12%
  • $20,000 college loan at 5%

When you use the debt snowball, after listing your debts from smallest to largest, you make minimum payments on all of them except the smallest. Throw every dollar you can scrimp and save against your smallest debt until it’s been eliminated, then move on to the next-smallest debt. Ramsey advocates this method because of the subtle psychological reenforcement it provides.

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The debt snowball method has vocal detractors who complain that the math doesn’t make sense. It’s true that if you use this method, you’ll pay more in the long-run than if you had the discipline to pay off your debts from highest interest rate to lowest interest rate, but what’s important is to find a repayment plan that you’ll stick to until the debt is gone.

For this reason, many people follow a third and final approach to debt repayment. They prioritize the debts that bug them the most. Most folks have certain debts that carry greater psychological weight than others. In Becky’s case, for example, it may be that the loan from her parents makes her feel guilty, while the student loan doesn’t bother her at all. In her case, she might choose to repay debts in the following order:

  • $5,000 loan from parents at 0%
  • $8,000 credit card balance at 12%
  • $2,000 computer loan at 10%
  • $3,000 car loan at 4%
  • $20,000 college loan at 5%

At the Man vs. Debt blog, Adam Baker calls this method the debt tsunami.

Ultimately, there’s no one right way to pay off debt. The most important thing when paying off your debts is to pay off your debts; the order in which you do so is irrelevant. Know yourself. Choose the method that makes the most sense for you and for your situation.

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