Three reasons to pay off your smallest debts first

In How to get rid of your debt once and for all I talked about the debt snowball and recommended that you list your debts from smallest to largest and then pay them off in that order. There are two schools of thought regarding this and it can be a hotly debated topic.

Many financial coaches will say that you should list your debts in order by the interest rate you are charged, and then pay off the highest interest rate debts first and gradually making your way toward the ones with the lowest interest rate . They argue, and correctly so, that by paying the highest interest rate ones off first in the long run you’ll end up paying back less money because you are paying off your costlier debts first. This is very true. However, I think there are some very good reasons for paying off your lowest balance items first.

  1. First, while it is true that the math would say pay off the highest interest rate item first, the problem is getting out of debt isn’t really about math. Dave likes to say that personal finance is 80% behavior and only about 20% math. I strongly believe this to be true. If we were doing math we wouldn’t be borrowing money at 18-30% interest rates on our credit cards. We have to change the behaviour that got us into debt if we are ever going to really change our lives.

  2. This leads to the second reason. Getting out of debt is hard for most of us. We didn’t get ourselves into the mess we find ourselves in a couple of weeks. We aren’t very likely to be able to write a couple checks and magically be out of debt. It’s going to take a while and it is very easy to get discouraged along the way. By paying off the smaller debts first you can get some quick victories. Those victories makes us feel like we are accomplishing something. It’s  kind of like going on a diet. What happens that first week of your diet? You will probably lose a significant amount of weight. You step on the scales and see a 5 – 6 – 7 pound weight loss! It’s so encouraging. You know down deep that’s normal and it is usually mostly water. You probably haven’t lost that much actual fat. But still hey. I lost 5 pounds!!!! I’m feeling excited!!! The same principle is true in paying off debt. As you pay off those little debts, you may know down deep that they are just smaller debts, but still knowing that you never have to write that check or transfer money to that account again is a huge psychological boost. The other encouraging part is that as you pay off those little debts, your snowball starts to turn over and each month you are paying more and more on the next debt in line. At first maybe you are only paying $50-$100 on that smallest debt, but then in a couple of months you might find you are paying $200 a month, then a few months later it’s $500 a month, and things are really rocking. Then maybe a year in you are paying $1000 or even $2000 a month. By this point even though you are now paying your largest debts, you are knocking huge chunks off every month so you really feel like you are accomplishing something. This feeling of accomplishment can not be understated. It’s what really enables you to make that behavior change.

  3. Lastly, while it is true you may pay a little more in interest, it may not be as much as you might think. One of the real keys to getting out of debt is you need to be willing to sacrifice. Dave talks about gazelle intensity. What he means by this is we need to approach getting out of  debt with the intensity of a gazelle trying to escape a cheetah. You don’t get out of debt by making a half-hearted attempt. Those who succeed in getting out of debt are those that attack the debt with a vengeance. Cut your life style. No trips to restaurants. Get a side job. Sell stuff. Sell lots of stuff. Did I mention cutting lifestyle? The point is for a short time you need to make the sacrifices that most people are unwilling to make. You don’t want to live like this for the rest of your life. But for a short time go a little crazy. It’s ok if your broke friends think you went off the deep end. (Actually, that probably means you are right on track.) Dave’s famous line is “Live like no one else, so later on you can live like no one else.” The point is be willing to make deep sacrifices for a short time, so that later on you are financially healthy and can enjoy life in a way that few people do. So what does this have to do with the order you pay things off? Well, if you really are gazelle intense you are going to be able to pay your debts off, probably much faster than you think possible. If your debt repayment plan is going to take 10 years then sure you are going to end up paying a lot of interest. But the average person in Financial Peace University pays off their debts in 18-24 months. If you pay things off in 18 months, the actual extra amount of interest you pay really isn’t likely to amount to that much. For me the psychological benefits provided by paying things off from smallest to largest far outweigh the few dollars you save on interest paying off the high interest rate ones first.

The bottom line is I want you to get out of debt no matter how you go about doing it. If you are sold on the math of paying the high interest rate items off first, and you really are going to follow through because you are sick of debt and will do whatever it takes to get out of that bondage then good for you. Bravo! I’m excited for you. But, for most people I really believe the encouragement that comes from working your way through the debts from smallest to largest will give them the strength to make it through when discouragement would tell them to quit.

Hopefully the posts this week have inspired you to start taking control back in your financial life. We did it. You can do it too! Be a gazelle and outrun that cheetah!!!  


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