Paying off debt question?

Question

I have been listening to Dave Ramsey's radio show the last couple of weeks and he keeps talking about how you pay down your smallest debt first and then the next smallest and the next smallest and so on. To me logic would suggest that you should pay off your highest interest loan first and then your next highest interest. Does anybody know why one or the other is right? Graphs or numbers or something would be greatly appreciated in that Dave isn't the only person I have heard that from, but common sense is so contradictory in this case.

Thanks!

Answer 1

Financial Advisers typically recommend paying of debts with the highest interest rates and larger balances first- keeping in mind that you want to maintain all open accounts in good standing- the reason is the interest on a larger balance will be more than the balance on a small account.

Smaller account payoffs are consider milestone payoffs- but typically these balances are collections and such and they will adversely affect your credit for 90 days- so the theory is let sleeping dogs lie and work on the higher interest rates and larger balances.

Keep in mind if you do have equity in your home now is a better time to maintain it or consider an equity line to absorb expense like auto loans but be discerning and always check with you CFA or CPA or utilize a Licensed Professional for assistance.

Answer 2

Suzie Orman recommends that your pay off the highest interest rate debt first.  It would make no sense to continue to allow the higher interest to keep accumulating.  It does make sense to pay off the smaller debt first IF all interest rates are equal,  so that you can eliminate an entire debt from your credit report.

Hope this clears it up.

Tex

Answer 3

I agree with your logic, but also agree with what Dave Ramsey says - he puts a lot in the 'feedback"element of it, and the quick rewards of paying off a small debt and realizing how good it feels. It kind of makes sense to me from a motivation point of view, but I've never sat down and looked at it on a spreadsheet to see which way gives the smallest payback amount, which is what you want really...

He also talks about using a smallish sledgehammer (your small payback power at the start of the program) to crack the small debts, then tackle the larger debts quicker as your sledgehammer gets bigger. If you're stuck with only being able to make minimum payment plus say 5% on a large high interest debt, you may see your balance growing rather than shrinking, and the situaiton will never change until/unless you can increase your payback power by either increasing income or removing other debt and redirecting the other payments to the big payment. Again, you need to knock a spreadsheet together to see which works economically for your situation

Answer 4

Your feelings are right in my opinion.  Take the highest interest card you have and put the max money on it.  Pay just the min on everything else.  When that one is gone move to the next highest. That way you remove the most principal each month from the highest interest card.  You dont need a graph to understand that.  Good luck my friend!

Answer 5

I think he is saying that because it is easier to pay off a small debt than a larger one. Pay if off, then it is out of the way and move on to the next one and so on until your are debt free.

Answer 6

Pertaining to your credit the interest doesn't matter. The more open accounts the lower your credit score will be. The more you pay off and it says you did it on time and paid in full etc the better your credit score will reflect.

say your largest bill is 10k and your three smallest bills equal 10k. With 10k you could pay the bottom 3 and you have three positives on your credit or you can pay the 1 and have only 1 positive. to your credit the $ amt of your debt is not what matters, it's how many open accts you have.

Check out Credit Secrets Bible for more info about improving credit score. We learned SO much we didn't know.