Which debt should I clear first?

If you are determined to pay off your debts, then you may have heard of “snowballing” – it’s the approach where you pay the minimum to all of your debts except one, which you overpay by as much as possible each month. (If you can’t afford to pay the minimums to your debts, snowballing isn’t for you – look at A simple roadmap of debt solutions to see what your options are.)

But which debt should you overpay first? In this article two of Britain’s top personal finance bloggers explain why they have opposite views on this!

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Graham who runs the Moneystepper website thinks it’s a matter of maths and logic:

Repaying the highest interest is financially efficient!

When it comes to tackling your debt, people generally subscribe to one of two schools of thought:

• “Avalanche” method: you repay down your debts in decreasing order of interest rate
• “Snowball” method: you repay down your debts in increasing order of amount

Now, I’m obliged to say that when it comes to paying down debt, there is no wrong answer. If you make a plan to repay down your debt and get your finances back on track, who am I to criticise your repayment method?

Well, however rhetorical that question, I still have an answer: “I’m a mathematician”. And, as such, whilst I may be able to stomach the fact that there is no wrong answer, I can’t overlook the fact that there is a financially and mathematically inefficient and sub-optimal answer! And that answer is the snowball method.

A simple example

Let me demonstrate via a very simple, and realistic, example. Johnny has gone himself into a financial pickle, and when he lists all of his outstanding debts, smallest first, they look like this:

Johnny decides that he wants to tackle his debts and he has a total of £500 a month to place against his debts. We’ll assume that the minimum payment each month on all loans is 1% of the outstanding balance, and then Johnny assigns the remainder of the £500 either via the snowball or avalanche method.

• Under the snowball method, Johnny pays down the debts in the order listed above. Following this plan, Johnny will repay all of his £12,000 in debts in 28 months and pay total interest on his loans of £2,707.76.
• Under the avalanche method, Johnny pays down the debts starting with the highest interest (payday loan at 79.9%), then the second highest and so on. In total, he will repay all of his £12,000 debts in 25 months and pay total interest on his loans of £1,185.65.

Therefore, under the avalanche method, Johnny will spend 3 months less in his debt nightmare, and he will save a whopping £1,522.11. The conclusion applies to any set of loans and credit cards you might have; there is another one on my blog.

What about motivation?

Now, the many advocates of the snowball method state that personal finance is not a “maths game”, but instead that psychology is a more important factor. The argument is that the sense of achievement when you pay down that first small loan quickly will drive you on to pay down more debts.

However, what is the equivalent motivating factor with the avalanche method? Well, in this example, that motivating factor is knowing that you will save £1,500 and you’ll be out of your debt quagmire 3 months quicker.

Now, I’m no shrink. But, if you ask me if I’ve rather celebrate an arbitrary milestone of putting a line through something on a piece of paper, or you’ll have an extra £1,500 in your pocket to put towards your financial future, it’s an easy answer.

So, for all snowball method supporters out there, I’d encourage you to take a step back and do the maths. Then, watching that outstanding debt balance decrease quicker every month should be more than enough motivation to keep you pushing towards your debt-free date.

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Haley who blogs over at Disease Called Debt doesn’t agree. Here is her story of repaying her own debts:

Forget the Math & Snowball Your Smallest Debts First

When it comes to debt snowballing, you can choose either to pay off the highest interest debt first or the smallest debt that you have.

You might think that the logical answer points to paying off the highest interest debt first, because well, high interest is bad. Right?

High interest on your debt isn’t great, but sometimes, logic doesn’t always equal results. I believe this is one of those cases. Because, there’s one sticky little issue with paying off the highest interest debt first and it’s simply this: it could take you a very long time to clear that first debt.

When you’re trying to pay off your highest interest debt first, your progress on actually getting out of debt could seem very slow – because so much of your repayments will be going towards interest.

Why should that be a problem?

The fact is that we, as human beings, thrive on motivation to get things done in our lives. If we don’t have motivation, what’s keeping us from giving up?

The reason why many people fail at getting out of debt is because they can’t see any progress and so they just give up. I should know, because I tried and failed several times over the years to clear my debts by paying off the highest interest debt first.

Each time, I wasn’t motivated enough to continue – I just couldn’t see results fast enough. The truth is that I didn’t even clear one debt in its entirety this way.

Then finally, my husband and I managed to clear our combined debt of £41K in 22 months using the smallest debt snowball method.

How the smallest debt snowball method works in practice

I want to encourage you to put interest rates to the back of your mind for a minute. The idea with this method is that you make minimum payments towards all your debts except for the smallest one.

Throw any extra money that you can find towards that smallest debt. It’ll probably be eliminated quite quickly, with it being your smallest debt and all.

That’s the beauty of this method of debt repayment, right there. That smallest debt will be gone in no time – one less debt to worry about before you know it. Even if you give up at this point, that one debt will be gone!

As an example, let’s say that your smallest debt requires a minimum repayment of £20. After doing some calculations and cutbacks, you find that you can overpay this one debt by £50 per month. After a few months, you manage to clear that debt.

You’ll then move onto paying the next smallest debt that you have, in exactly the same way until that too has been eliminated. Only this time, you’ll have £70 to throw at this particular debt – the amount you were managing to find before, plus the amount that you were paying as a minimum repayment on the previous debt.

You’ll work your way up your “debt ladder”, eliminating debts in order of size from smallest to largest. Each time you clear another debt, you’ll have more money to use to snowball the next.

When you’re down to just one debt left, all of your smaller debts will have been eliminated and along with them, those pesky monthly payments. Although this last debt will be the largest one, you’ll also have a lot more spare cash to attack it with a vengeance!

Why does smallest debt snowballing work so effectively?

It’s all down to motivation. Once you’ve cleared one debt, you’ll feel great! Once you’ve cleared two, you’ll feel amazing! Those positive feelings will have a direct impact on your attitude to debt repayment.

You’ll want to continue, because you’ll be able to see that this method of debt repayment WORKS.

There are a number of ways to approach debt repayment and there isn’t a one size fits all approach. Many people succeed in clearing their debt by using the smallest debt snowball method. The question is, will you?

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Here at Debt Camel, I take a practical view. This isn’t really a completely black-or-white decision. If you list your debts with the interest rate you are paying, it will often be “obvious” what your first target should be. There may be a very small one that could go in the first two months. Or a horrible interest rate one that just has to be target number one.

And if you have “difficult” debts such as guarantor loans or logbook loans, they should always be your top priority. See Which debt should I clear first? which looks at one reader’s options.

The important thing is to make a definite decision and then go for it! And when that first debt goes, update your list and decide which next debt to target.

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