Comments on: Paying off Debt: Lowest Balance or Highest Interest First?

By: used tires

used tires — Thu, 13 Aug 2009 23:36:05 +0000

My question is this.. if you wan’t to increase you’re credit score, which is best to pay off first?? The highest interest? Or the lowest debt balance? Or does it not matter?

Thanks,

Jean

By: Kevin

Kevin — Fri, 31 Jul 2009 22:33:52 +0000

There are more factors involved in debt payback than just interest rate and lowest balance. People forget about the term (how many months left). People forget about the TYPE of interest rate- fixed or variable. People forget about the TYPE of debt- closed end (like a mortgage) or open ended (like a credit card). All of these factors are involved in debt payback. They ALL have to be taken into consideration when deciding which debt gets your extra payment. Don’t just fall victim to “highest interest rate” or “lowest balance.” There is more to this than meets the eye. Think carefully.

By: Blogging Banks

Blogging Banks — Fri, 31 Jul 2009 12:03:11 +0000

For me it has always been pay of the highest interest rate first. I disagree on points two, because I find it very likely that the people who do the wrong things, even for motivational purposes have not learned their lesson. Furthermore, by paying off the smallest balance first, the monthly minimum payments won’t drop by much versus paying the highest interest first.

The correct thing to do is step number one. Anything else is irrational and is exactly why we are in a financial mess to begin with!

By: Marie

Marie — Thu, 30 Jul 2009 22:34:06 +0000

Our mortgage is at 6% and carrying PMI but we decided to knock out a 5k student loan at 4.25% to increase our cash flow and accomplish something. Since we still need 22k to ditch the PMI we discovered last month that we hit the number of months of consecutive repayment early with our overpayments on the student loan and they dropped the interest rate.

Therefore there are sometimes benefits within your debt situation to also be considered. We will throw 1500 at the other student loan to knock its interest rate down before eliminating PMI on the mortgage.

By: Ms Save Money

Ms Save Money — Thu, 30 Jul 2009 18:33:44 +0000

Phi,

That’s actually very interesting and true – once you’re able to pay off a debt fast it does motivate you more. And even more so when you know your credit score got a big boost from it. Last December my credit score was only at 680 and now it’s at 765 after I got it checked for an auto loan. :)

By: WP

WP — Thu, 30 Jul 2009 17:55:58 +0000

This is a very good article, and it is a very good idea to contrast what seems to be the two main competing debt repayment ideologies. I really believe that there is no one right answer that is right for everyone. I agree with the people that are suggesting that you should do whats right for you. Although paying down the high interest rate makes mathematical sense, that doesn’t necessarily work for everyone. Many people need the little kick that comes from having a few small victories along the way.

By: Kathryn

Kathryn — Wed, 29 Jul 2009 20:30:46 +0000

O.H. I couldn’t agree with you more. It’s about whatever it will take to motivate that individual. Everyone is different and that’s ok.

I like the messy house analogy.

By: O.H.

O.H. — Wed, 29 Jul 2009 20:28:15 +0000

I think for a lot of people, especially those who have problems with debt, attacking debt is like attacking a mess in their house. If the entire house is a mess, it can be so daunting, they do nothing about it. However, if they just start small, room by room, they will see how good one room looks and be motivated to finish the rest.

And therein is the key: motivatation. For those who have issues with debt, I believe paying the smaller debts can be more motivating.

By: RB @ RichBy30RetireBy40

RB @ RichBy30RetireBy40 — Wed, 29 Jul 2009 06:59:10 +0000

Pay off the annoying small but prevalent small debt first, no matter the interest rate. Then learn to LOVE the debt you have with the smallest interest rates, and pay off the highest ones.

Love this topic.

Cheers,

Rich By 30 Retire By 40

By: Phi

Phi — Wed, 29 Jul 2009 00:25:29 +0000

I’m definitely the right-brained, creative type. If I pay off a loan quickly, it’ll get me to oftentimes put even more money into my remaining loans each month once I am motivated.

Interesting article.

By: FirstGenerationWealth

FirstGenerationWealth — Tue, 28 Jul 2009 23:42:31 +0000

The most Important thing is a plan that allows the client to stay motivated. You cant go from Visa rich to re-using coffee filters overnight. A realistic, incramental plan is best.

One comment for people looking at the consolidation option would be to take a ooan option vs the Line of credit. The main reason for this is to have a set structured monthly payment with an end date in site. Thats a motivation piece. Most lender wont Amm more than 36 months on a consolidation but if you can stretch to 48 or 60 months thats an option to keep the required payment down. One trick I do for clients is setup a loan payment that fits their budget and keeps their ability to spend in check but give them a payment amount that will pay off their loan faster. They can speed up their payment schedule as much as possible but still have the required payment there in case they fall off the wagon and will still be debt free in XX months. I, depending on the client, will require closure of credit facilities I am re-writing and leave minimal cash flow credit available to minimize racking up more debt.

Consolidation lines of credit are a credit card with a better rate. You put money on em and take more out.

Just my $.02

By: YYC27

YYC27 — Tue, 28 Jul 2009 22:56:49 +0000

A number of years back I was in really poor financial health. I had a bunch of bad credit cards, and a line of credit racked up. When I was in a position to start repaying them, I decided on a set minimum I would pay to each debt (in the neighbourhood of 3% of the then outstanding balance). That was the minimum amount I would pay towards that debt each month until it was paid off. Any extra money went to the debt with the highest interest rate. As each debt got paid off, it’s minimum was added onto the debt with the next-highest interest rate.

By: Debt Consolidation Regina

Debt Consolidation Regina — Tue, 28 Jul 2009 21:04:44 +0000

This is a great article! I agree that the three approaches mentioned are the most common in paying off the debt. It is very important for a person to choose what method works well for their lifestyle and current financial standing. Having a budget and sticking by it is also vital in ensuring that further debt is not accumulated.

By: J

Tue, 28 Jul 2009 19:31:19 +0000

What most people don’t realize is that one of the factors taken into account when calculating your credit rating is not just your total debt but also your balance in relation to your maximum. that means that if you are within 75% of your loan maximum or credit card limit, it counts as a black mark on your rating. So if you pay off your highest interest debt while leaving lower interest debts near your max, your actually worse off from a credit rating standpoint.

By: Ms Save Money

Ms Save Money — Tue, 28 Jul 2009 19:00:03 +0000

Good article – I agree with everyone here – it’s best to pay off the highest interest first. Also if you have the money to pay something off rt away – you should just pay off the balance in full – this looks good on your credit history.

Going with what FT said – if you consolidate your credit cards – it may lower your credit score but if you’re responsible your credit score will rebound pretty fast. Especially with a lower interest you can pay more of the principal off. But if you just pay the minimum there is a flag on your credit score that says you’re just paying the minimum. If you know you have to consolidate you should – which will be good for you, but if you consolidate over and over again that’s not a good sign.

By: Bryce

Bryce — Tue, 28 Jul 2009 18:57:38 +0000

cannon_fodder: i agree with you that paying the high interest is the way to go, but for all might not be “the most financially sound method.” If a person pays off the smaller balance, lower interest debt first as opposed to paying a larger higher-interest debt but then loses hope as the number of loans is the same, THAT should also be considered financially sound.

By: cannon_fodder

cannon_fodder — Tue, 28 Jul 2009 18:23:42 +0000

I typically don’t have debt (other than the mortgage) but I would look at which is the highest effective AFTER TAX interest rate. I have a tax deductible HELOC which is higher than my mortgage, but not when tax is factored in. Thus, my focus is on paying down the mortgage.

I can understand the psychology of the approach to pay down smaller debts first so that some personal satisfaction is achieved through goal accomplishment.

But, I’m a logical, analytical person so it’s obvious why I choose the most financially sound method.

By: Ninjaman

Ninjaman — Tue, 28 Jul 2009 18:20:09 +0000

As a person working in the financial industry it was my hope to pay off the highest interest debt first as I understood that even with the deductibility of the student loan interest accounted for, I am still getting hosed.

That said, when my wife and I came up with a plan we agreed that the actual interest rate would be the secondary factor in deciding which debt is paid off first. The primary choice would be the loan with the highest monthly minimum payment. My wife liked the idea of freeing up cashflow as quickly as possible for any unexpected happenings. With a little bit of fighting I convinced her that while we may pay off the loan, the monthly payment should be tacked on to the next targeted debt. That way my wife gets to feel the satisfaction of paying off a loan, and I get to tell myself that the additional minimum payments while I save up for the lump sum pay down are saving me interest. We also confirmed that we can reset to the minimum payment at any time if we need the cash flow, which still gives my wife the flexibility she wants.

By: Cash Canuck

Cash Canuck — Tue, 28 Jul 2009 15:30:17 +0000

I would pay off the debt that is psychologically most draining (or most annoying, like other posters have said). I once owed money to my father-in-law, he charged me zero interest but his was the debt I paid first once I had a decent income, then I paid credit cards (highest interest) then my student loans (highest dollar amount).

I think owing money to family members is poisonous, and should be avoided at all costs, unless you have a formal arrangement for repayment.

By: Kathryn

Kathryn — Tue, 28 Jul 2009 14:36:39 +0000

NoDebtGuy: That skit is a classic. It’s my all time favourite SNL skit.

FT: Good point about the debt consolidation changing credit score. This should be considered in the overall picture.

MGL: Very true about the most annoying one. I may have to add that to my list!

Cailin: Instant gratification really helps! I’ve seen a number of people kick start their plan with a tax refund! Only you know yourself well enough to know what would work and what wouldn’t work. It’s great that you took the initiative to cut your credit limits as a way to restrict yourself knowing this was something you needed.

Digger: Thanks. One of my passions is adult education and training. One of the main themes that comes out of adult education is respect for the adult learner. Many of the people I work with are significantly brighter than I am. My role is to get them thinking and use the knowledge they already have. It’s not about telling them what to do. It’s about helping them discover how to do it themselves.

M Hawk: Owed income tax would be at the top of my annoying list too. Best of luck to your partner working off his debts.