Mathematically, it’s obvious that paying off loans with the highest interests rate first makes the most financial sense but as you may know, some financial experts promote “paying off the smallest loans first”. Why do they do that? Let’s take a look today.
Smallest Loan First
The smallest loans first method is simple. Instead of paying off debt with the highest interest rates (ie, the ones with the least favorable terms), you put that aside and list out all your debt sorted by the amount owed. Then, you pay the minimum payment of all your loans each month and pile all other available income for debt repayment into the loan with the smallest amount outstanding. Once the first debt is repaid, you try to repay the second smallest debt you owe and so on.
The argument for this approach is that eliminating bills are so satisfying it will be easier to stay on track with the overall debt repayment plan. The positive and quick feedback will have a great impact on your commitment to repaying your debt and will overcome the increase in interests that you need to pay.
Highest Interest Rates First
With this method, sort your debt by interest rates. Then try to pay off loans with the highest interest rates first by paying the minimum payment of all the other loans. Once one loan is paid in full, rinse and repeat with the next one down the list.
The facts are undeniable. Paying off highest rates first saves you the most total interests. In turn, it helps you pay off your debt the quickest because more of your hard earned money is going towards principal reduction.
Which Debt Snowball Method is Better?
While the math isn’t in our favor, I believe the smallest loan first method works for the majority. Being able to eliminate one of our debt payments provides a huge psychological boost and for most people, positive encouragement is not only helpful but necessary. Without periodic encouragement, it’s very difficult to be disciplined enough to pay off all our debt.
I know that if I’m encouraged, I am more willing to do more. Therefore, being able to cross off debts may prompt me to save more, thereby allowing me to put even more towards my debts.
Sure the math doesn’t make sense, but Algebra (or is it Calculus?) in school never did either.
Want more ways to reduce debt? Here are 25 ways to pay off your debt.