If you have/had CC debt, which method is/was the best to become debt free?

[TimC]

I'd move next door to TimC and "borrow" money from him.

 

My f'n neighbors. I should quit work and open up a loan shark bizness. I'm not going to apologize I'm the only one that didn't make some crap fiscal decisions. Of course, I make you pledge yer allegiance to King Bush.

 

I was in debt after school close to 20 years ago...probably only about $10,000...but that was a lot back then. Dave Ramsay wasn't invented yet, but I did it his way. I did my own Lotus 1-2-3 spreadsheet and did up my own budget. I knocked out the smallest and rolled that into the next biggest. I did get alot of satisfaction paying off the bills quickly. All the interest rates were basically the same for the most part. I don't know successful I would've been with it if I would've tried to get fancy and never seen any progress by paying off the high interest rates ones first. There is a lot to be said for seeing that zero balance.

 

I completely changed my lifestyle. I was a drunk partier driving a new car and living in a very nice apartment wining and dining nightly. I didn't renew my apartment lease, moved back in with the parents, quit eating out, drinking, bar-hopping, buying every color of Members Only jackets, etc. Broke up with my fiance who was sucking me dry for every penny I had. She had rich parents that would bail her out every 6 months...I didn't. After I crawled out of debt, I kept saving to buy my first house. Getting rid of rent was the key for me. I was able to do it in about a year as opposed to God-knows-how-long otherwise. It was a tought time for me, for sure. Thankfully, I did it and I was better off for sacrificing like that in the long run.

[I Like Soup]

My f'n neighbors. I should quit work and open up a loan shark bizness. I'm not going to apologize I'm the only one that didn't make some crap fiscal decisions. Of course, I make you pledge yer allegiance to King Bush.

 

I was in debt after school close to 20 years ago...probably only about $10,000...but that was a lot back then. Dave Ramsay wasn't invented yet, but I did it his way. I did my own Lotus 1-2-3 spreadsheet and did up my own budget. I knocked out the smallest and rolled that into the next biggest. I did get alot of satisfaction paying off the bills quickly. All the interest rates were basically the same for the most part. I don't know successful I would've been with it if I would've tried to get fancy and never seen any progress by paying off the high interest rates ones first. There is a lot to be said for seeing that zero balance.

 

I completely changed my lifestyle. I was a drunk partier driving a new car and living in a very nice apartment wining and dining nightly. I didn't renew my apartment lease, moved back in with the parents, quit eating out, drinking, bar-hopping, buying every color of Members Only jackets, etc. Broke up with my fiance who was sucking me dry for every penny I had. She had rich parents that would bail her out every 6 months...I didn't. After I crawled out of debt, I kept saving to buy my first house. Getting rid of rent was the key for me. I was able to do it in about a year as opposed to God-knows-how-long otherwise. It was a tought time for me, for sure. Thankfully, I did it and I was better off for sacrificing like that in the long run.

 

Why do you hate America?

[The Holy Roller]

I'd move next door to TimC and "borrow" money from him.

 

[wiegie]

When I came out of graduate school, I had quite a bit of CC debt.

 

One thing that helped me was making a simple excel file in which I listed my individual debts and them summed them up to get my total debt. Such as (numbers are lower than they were in real life):

 

CC #1	 $4000CC #2	 $3700Debt 3	$5000-----Total	$12,700

 

 

Then each month I would make a new column listing my debts for that month. Then I would graph my total debt over time. I would pay off the debts with the highest interest rates first, but seeing the graph decline would give me a similar kind of satisfaction as paying off the debts "snowball" style would give. Additionally, seeing how my debt changed from month-to-month gave me a very clear indication if I was slipping in terms of not paying off the debt as fast I wanted to. (And the graph also very clearly conveyed to my wife the same thing.)

 

I will be honest and say that I didn't update my graphs every month and perhaps the most useful experience was looking at a graph of my total debt one month and realizing that because of increases in unnecessary spending, we had actually gone into deeper debt than we had been in 4 months earlier--even though I felt like we had been making decent progress.

 

Overall, the method worked pretty well for us and I recommend it.

Edited April 14, 2010 by wiegie

[Inhiding]

We are using our tax return to pay off our Tahoe, thus freeing up $462 a month. Got my credit card closed and a payment plan with a lower APR. Gonna take that $462 and pay off the CC in half the time.

 

Here is a sheet that shows the difference in the Highest First vs Snowball effect.

 

Debt Calculator

 

While applying the tax return to the CC and working the highest first method would save $1,200 the next two years, I would rather free up the smallest balances first and only get to 1 bill a month, the CC. Working the snowball effect I get it paid off 2 months sooner, negating the $1,200 savings.

 

Debt free by October 2012! Yea, we suck and go into debt big time.. but I love America.

[TimC]

Why do you hate America?

 

Because of my debt, I never got the new lavender Members Only jacket guaranteed to make Squeegie swoon. So yeah, I hate America.

[Big John]

Because of my debt, I never got the new lavender Members Only jacket guaranteed to make Squeegie swoon. So yeah, I hate America.

Just play your Hall and Oates to her. That would do the trick.

[wiegie]

While applying the tax return to the CC and working the highest first method would save $1,200 the next two years, I would rather free up the smallest balances first and only get to 1 bill a month, the CC. Working the snowball effect I get it paid off 2 months sooner, negating the $1,200 savings.

you must be doing something wrong, because that makes no sense

[BillyBalata]

this is the method I've been following...

 

I've been paying off hugh chunks on the one with the highest rate and then paying a little more than the minimum on the others....this way I still work some off the other cards, but take off massive chunks from the card with the highest interest rate...

 

 

wow...yet you preach over and over about too many people spending beyond their means when they should be saving.

[rajncajn]

wow...yet you preach over and over about too many people spending beyond their means when they should be saving.

Lessons learned...

[Inhiding]

you must be doing something wrong, because that makes no sense

 

We can apply more money in a faster amount of time when we pay off our smaller debts. We have a lot, (A LOT) of credit card debt on one card, which we froze at a lower APR and fixed payments. By paying the larger amounts means we will pay off all the debts, and apply those small payments to the large credit card amount. Paying it off 2 months sooner if we did the Highest first method. That would save us $1,200 over those 2 months...

[wiegie]

We can apply more money in a faster amount of time when we pay off our smaller debts. We have a lot, (A LOT) of credit card debt on one card, which we froze at a lower APR and fixed payments. By paying the larger amounts means we will pay off all the debts, and apply those small payments to the large credit card amount. Paying it off 2 months sooner if we did the Highest first method. That would save us $1,200 over those 2 months...

still makes no sense

 

There is NO way that you can save money paying off lower interest rate debts first rather than paying off the higher interest rate debts first. Mathematically it just doesn't work.

[Avernus]

wow...yet you preach over and over about too many people spending beyond their means when they should be saving.

 

where in that post did I say I wasn't saving?

 

saving = not paying off debt and getting my freedom back?

 

edit: maybe I should mention that I have less than $6000 in CC debt...does this help?

Edited April 15, 2010 by Avernus

[Avernus]

still makes no sense

 

There is NO way that you can save money paying off lower interest rate debts first rather than paying off the higher interest rate debts first. Mathematically it just doesn't work.

 

exactly, imo you shoot off the head and then bury the rest...

[ljbrun]

While paying off the cc with the highest interest first will pay down your debt quickest you may want to pay off the cc with the smallest balance at the same time (or get a another, new card). This would give you a cc that you could use to make purchases that could be paid off each month without interest. Otherwise, unless you stopped using your cc's, you would be adding debt to one of your other cc's on which you're paying interest.

 

edit: Just thought of this. Perhaps you could temporarily reduce the amount of tax withheld from your paycheck and use it to pay down your cc debt. Sort of an interest free loan. Later, you can adjust the amount withheld back up.

Edited April 15, 2010 by ljbrun

[Inhiding]

still makes no sense

 

There is NO way that you can save money paying off lower interest rate debts first rather than paying off the higher interest rate debts first. Mathematically it just doesn't work.

 

you are right, i looked at the numbers wrong, and yes we do pay $1,000 in interest more by doing lowest balance first, but we pay it off 2 months faster, which saves us 2 months of payments versus the Highest Balance. That is where I said we are saving money, or make up the difference. Regardless of what saves more money, being out of work and paying off one bill entirely with the tax refund will give us some breathing room.

[I Like Soup]

While paying off the cc with the highest interest first will pay down your debt quickest you may want to pay off the cc with the smallest balance at the same time (or get a another, new card). This would give you a cc that you could use to make purchases that could be paid off each month without interest. Otherwise, unless you stopped using your cc's, you would be adding debt to one of your other cc's on which you're paying interest.

 

edit: Just thought of this. Perhaps you could temporarily reduce the amount of tax withheld from your paycheck and use it to pay down your cc debt. Sort of an interest free loan. Later, you can adjust the amount withheld back up.

Seems to me the use of the CC is what got the individual in that position in the first place. I'd recommend a complete change in purchasing habits until things are under control.

 

I guess you could change the amount withheld on your taxes. You can actually specify a monetary amount if you wish, not just picking a number for deductions. I'd make sure to put that amount right on to the credit cards and not get lax!

[The Wolf]

still makes no sense

 

There is NO way that you can save money paying off lower interest rate debts first rather than paying off the higher interest rate debts first. Mathematically it just doesn't work.

 

Inhiding states in post 41 that you are correct, but let me play DA for a bit...what if the lower interest cards had much larger balances than did the higher interest ones...wouldn't his plan (although it wasn't really his plan) then make sense?

[Avernus]

Inhiding states in post 41 that you are correct, but let me play DA for a bit...what if the lower interest cards had much larger balances than did the higher interest ones...wouldn't his plan (although it wasn't really his plan) then make sense?

 

 

it depends on what the limit is....in my case the card with the highest limit also has the highest interest rate thanks to Washington Mutual changing over to Chase Bank ....my interest nearly tripled after this transition...

[Big Country]

Inhiding states in post 41 that you are correct, but let me play DA for a bit...what if the lower interest cards had much larger balances than did the higher interest ones...wouldn't his plan (although it wasn't really his plan) then make sense?

 

This article does all the math I highlighted some key takeaways at the end.

 

Summary is that there are some "Perfect Storm" scenarios where Ramsey's approach may equal the highest interest debt first method in terms of time and cost to pay off the debt, but it is a mathematical impossibility for it to ever do better. Ramsey's approach only makes sense if you need the psychological boost of paying something off in order to keep going, but it does not make financial sense strictly speaking.

 

If you’re familiar with Dave Ramsey, then you’ve no doubt heard of his ’snowball’ approach to paying down your debt. In short, Ramsey suggests that you make minimum payments on all but the debt with the lowest balance. Once the low-balance debt is paid off, you add the dollars that had been going there to what you’ve been paying against the next lowest debt. And so on. The idea is to pick up steam in paying down your debts by knocking them out one by one, and piling up the payments that would have gone to each of the paid off debts in order to knock out the next one. Sounds enticing, but is it a good idea?

 

To my mind, what you should really be doing is paying down the debts with the highest interest rate, regardless of balance. It just makes intuitive sense to pay off the most costly debts first. Once the debt with the highest interest rate is paid off, add those dollars to what you’ve been paying on the debt with the next highest interest rate, and so on. So who’s right?

 

I was actually inspired to look into this in greater detail by a recent post over at the Wealthy Blogger (Update: That site, and thus the post, have gone missing). In that post, Mike introduces yet another approach. As outlined in The Automatic Millionaire, this approach is based on the ratio of the outstanding balance to the minimum amount due. Divide the latter into the former, and concentrate your payments on the debt with the lowest resulting value. Once that’s paid, add the dollars that had been going there to what you’ve been paying on the debt with the next lowest ratio. Lather, rinse, repeat. Again, sounds like it might be a good idea. So let’s look deeper.

 

Consider a family with the following debts:

 

Visa ($7,500 @ 13%, minimum payment = $150/month)

MasterCard ($10,000 @ 19%, minimum payment = $250/month)

Car Loan ($5,000 @ 8%, minimum payment = $275/month)

 

Note that I essentially picked these values out of thin air.

 

Now, let’s first consider what happens when you make only the minimum payments month after month:

 

Visa:

Months to pay in full: 72

Total amount paid: $10,685.54

Total interest paid: $3,185.54

 

MasterCard:

Months to pay in full: 63

Total amount paid: $15,544.23

Total interest paid: $5,544.23

 

Car Loan:

Months to pay in full: 20

Total amount paid: $5,310.14

Total interest paid: $310.14

 

So it would take a grand total of 72 months and $31,539.91 to pay off the initial $22,500 in debt. Not too good.

 

Now let’s assume our hypothetical couple can actually afford to pay $1,000 per month toward their debts, rather than just making the minimum payments. What’s the best way to allocate these dollars? According to Ramsey, they should attack the car loan first, since it has the lowest balance. In other words, they’ll be paying $150/month toward their Visa bill, $250/month toward their MasterCard, and the balance ($600/month) toward the car loan. Using this approach, the car loan gets paid as follows:

 

Car Loan:

Months to pay in full: 9

Total amount paid: $5,126.70

Total interest paid: $126.70

 

At that point, the next highest balance is the Visa, so they add the $600/month from the car loan to the $150/month they already been paying, and they finish off the Visa.

 

Visa:

Months to pay in full: 19

Total amount paid: $8,477.38

Total interest paid: $977.38

 

And from this point on, the entire $1,000 gets poured into the MasterCard until it’s gone.

 

MasterCard:

Months to pay in full: 27

Total amount paid: $13,013.74

Total interest paid: $3,013.74

 

So it’s all done in 27 months at a cost of $26,617.82. That’s a net savings of 45 months and $4,922.09 in interest payments. Not too shabby. But could they do better?

 

Let’s look at what would happen if they hit the highest interest rate first. In this case, they’d attack the MasterCard, Visa, and car loan, in that order. The result? The MasterCard ends up as follows:

 

MasterCard:

Months to pay in full: 20

Total amount paid: $11,572.27

Total interest paid: $1,572.27

 

Coincidentally, due to the lower initial balance, the car loan ends up getting paid off during that same month, even thought they’ve only been paying the minimum amount each month.

 

Car Loan:

Months to pay in full: 20

Total amount paid: $5,310.14

Total interest paid: $310.14

 

So now the whole ball of wax gets applied to the Visa, wiping it out as follows.

 

Visa:

Months to pay in full: 26

Total amount paid: $9,093.73

Total interest paid: $1,593.73

 

So they’re out of debt in 26 months at a total cost of $25,976.14. That’s a month sooner, and they’ve saved an additional $641.68.

 

What about the approach advocated in The Automatic Millionaire? In this case, the car loan has the lowest initial ratio (and it turns out that it remains lower until it’s paid in full). Thus, as with Ramsey’s approach, our hypothetical couple starts out hitting the car loan the hardest, at $600/month.

 

Car Loan:

Months to pay in full: 9

Total amount paid: $5,126.70

Total interest paid: $126.70

 

At that point, the MasterCard has the lowest ratio (and it remains lower than the Visa until it’s paid off). So they switch to paying $850/month on their MasterCard and continue paying the minimum on their Visa.

 

MasterCard:

Months to pay in full: 21

Total amount paid: $12,052.55

Total interest paid: $2,052.55

 

And now it’s time to kill off the Visa.

 

Visa:

Months to pay in full: 27

Total amount paid: $9,114.65

Total interest paid: $1,614.65

 

Thus, in this case, the more convoluted, ratio-based approach takes the same length of time as Ramsey’s approach, although the remaining payments in that final month are slightly lower, bringing the total to $26,293.90. This is a savings over Ramsey’s approach of $323.92, owing to the fact that the vagaries of the numbers that I picked to start with resulted in the high-interest MasterCard getting attacked before the Visa.

 

The bottom line…

 

Snowball: 27 months; $26,617.82

High interest first: 26 months; $25,976.14

Automatic: 27 months; $26,293.90

 

If you work through the math, the best you can hope to do (in this specific case, as well as in any other) is to attack the highest interest rates first. In some cases, Ramsey’s approach will equal this approach (if lowest balances are on highest rate debts then the two approaches are the same), but it will never exceed it. Similarly, the approach advocated in The Automatic Millionaire will, in some cases, equal the performance of the high-rate approach – but only if the ratios work out such that the highest rate debts get paid first. But, like the ‘debt snowball,’ this approach will never beat the high-rate strategy.

 

With regard to Ramsey’s approach vs. the Automatic approach, the relative performance for any given scenario will depend on the numbers. In some cases, Ramsey’s approach will do better, in others it won’t.

 

I should note here that, although the numerical differences in this particular example aren’t that huge, they can work out to be pretty sizable depending on the amount of debt involved and the structuring of the interest rates.

 

This isn’t to say that an approach such as Ramsey’s isn’t worthwhile. For example, under Ramsey’s scheme, the first debt gets knocked out very quickly, and some people may need that psychological boost to keep at it. In contrast, it took twenty months to knock out the first debt under the high-rate scenario, although two debts (MasterCard and car loan) ended up getting knocked out that same month.

 

But for people with sufficient self-control, you can do better by paying off debts from highest to lowest interest rate. Then again, maybe people with self control don’t get into debt in the first place…

[bpwallace49]

Is this debate really still going?

[wiegie]

you are right, i looked at the numbers wrong, and yes we do pay $1,000 in interest more by doing lowest balance first, but we pay it off 2 months faster, which saves us 2 months of payments versus the Highest Balance. That is where I said we are saving money, or make up the difference. Regardless of what saves more money, being out of work and paying off one bill entirely with the tax refund will give us some breathing room.

I'm sorry, but it makes no sense that you are going to be able to pay off all of your debts quicker using the method you are describing--the math just can't work out that way.

[Azazello1313]

Pfftt...I had to figure out my own spreadsheet for running with average pace, etc. Pain in the ass.

 

Oh, and I've got an amortization spreadsheet I've used for years. While technically/financially the best way to go about lowering debt is going after the highest interest rate cards, I think you'll find the savings are extremely small. I subscribe to the Snowball Effect, humans are wacko animals and it is all about the psychology of motivating an individual!

 

Of course, a big thumbs up to anyone going the "hard" route and paying off debt the old fashion way and not going for bankruptcy.

 

I think you're right. unlike muck, I am pretty certain that there is no scenario (paying equal amounts) where doing anything other than paying down the highest rates first is going to get you paid off the fastest. it's simply impossible, unless you're missing payments and late fees become part of the equation. that said, the ultimate differences are probably going to be pretty small, and the psychological advantages likely more than make up for it.

 

seems like some solid advice would be, do the snowball thing for accounts that have similar interest rates (within say 5% of each other), but if you have balances with significantly higher or lower interest rates, prioritize those accordingly.

[Avernus]

I think you're right. unlike muck, I am pretty certain that there is no scenario (paying equal amounts) where doing anything other than paying down the highest rates first is going to get you paid off the fastest. it's simply impossible, unless you're missing payments and late fees become part of the equation. that said, the ultimate differences are probably going to be pretty small, and the psychological advantages likely more than make up for it.

 

seems like some solid advice would be, do the snowball thing for accounts that have similar interest rates (within say 5% of each other), but if you have balances with significantly higher or lower interest rates, prioritize those accordingly.

 

exactly...

 

if you need instant gratification, go the snowball route....

 

if you have patience and want to do things effectively, pay down the most difficult card before any of the others..