Which is the better strategy when paying off debts?

[Flower7]

Pay them off from smallest amount to highest amount.

Pay them off from highest to lowest interest rate.

[Naughtyboy71]

Pay them all off as quick as you can

[Wise4myage]

B, and double your payments.

[Flower7]

Very good strategy!

[Wise4myage]

Thanks.

[OlderAndWiser]

Are you paying minimum monthly payments and trying to increase your residual income as quickly as possible? Or trying to retire the debts as cheaply as possible?

[Flower7]

The second option. I’m trying to get rid of the bills completely because they are a nuisance. I also don’t want to waste any more money on their extra fees.

[OlderAndWiser]

Are you paying any fees other than finance charges?

[Flower7]

Interest. And occasionally, I’ve had to pay late fees.

And since there’s several days delay from when I submit the payments and the time when they actually remove it from my bank account, I’ve sometimes forgotten about it and end up getting an overdraft charge from the bank, if I hadn’t left enough money in my checking account.

[OlderAndWiser]

If the NSF fees are a significant part of your carrying cost, I would suggest that you pay of the smallest balances first. If two accounts have balances with roughly equal balances, pay off the accont with the higher interest rate first. Have you considered a bill consolidation loan to combine all of the accounts into one account to be paid off?

[Flower7]

I’ve had a consultation for the debt consolidation. But I decided against it because they would be charging a fee for their services. And extra fees are exactly what I’m trying to get away from!

[OlderAndWiser]

The debt consolidation to which you refer is different than what I am suggesting. Mu suggstion is a loan from a bank which s used to pay off all of your existing acconts and then you pay off the one loan account which is usually at a much lower interest rate than credit cards.

[abc3643]

C
It's a mix because that depends on the balances, interest rates, and what you are comfortable paying.

Let's do an example...

Suppose you have two debts, a loan and a credit card.

We'll look at these from three different payment scenarios, with everything being paid in monthly payments and the credit card does not have any additional fees or charges.

OK, before continuing, you need to know that the standard for interest rates is that they are given in APR (annual percentage rate). But, the reality is that the interest that you care about is the "per period" interest. So, if you are making monthly payments, then the per period interest is APR/12.

OK, here are the debts.
Credit Card Rate = 24% APR, so the per payment interest rate is 24/12 = 2.000%
Credit Card Debt = $10,000.
Loan Rate = 6% APR, so the per payment interest rate is 6/12 = 0.500%
Loan Debt = $50,000.

Scenario 1: We want to pay both of these off in 5 years, so that's 60 payments.
For this credit card, you'd be making 60 payments at $287.68/payment for a total of $17,260.08.
For this loan, you'd be making 60 payments at $966.64 for a total of $57,998.40.
The total for the two debts which had a total balance of $60,000 is $75,258.48.
The banks earned over $15,000 from you!

Scenario 2: We want to pay the loan off in 5 years, so that's 60 payments. But, we want to pay the credit card off in 2.5 years, so that's 30 payments.
For this credit card, you'd be making 30 payments at $446.50/payment for a total of $13395.00.
For this loan, you'd be making 60 payments at $966.64 for a total of $57,998.40.
The total for the two debts which had a total balance of $60,000 is $71,393.40.
The banks earned over $11,000 from you! But, compared to Scenario 1, you saved over $4000 by paying off the credit card in half the time.

Scenario 3: We want to pay the credit card off in 5 years, so that's 60 payments. But, we want to pay the loan off in 2.5 years, so that's 30 payments.
For this credit card, you'd be making 60 payments at $287.68/payment for a total of $17,260.08.
For this loan, you'd be making 30 payments at $1798.95 for a total of $53,968.50.
The total for the two debts which had a total balance of $60,000 is $71,225.58.
The banks earned over $11,000 from you! But, compared to Scenario 1, you saved over $4000 by paying off the loan in half the time. And, compared to Scenario 2, you saved about $150 more.

So, which is better?

Well, let's take a look at your total payments each month:
Scenario 1: $287.68 (credit card) + $966.64 (loan) = $1254.32 for 60 months
Scenario 2: $446.50 (credit card) + $966.64 (loan) = $1413.14 for 30 months
then $0 (credit card) + $966.64 (loan) = $966.64 for 30 months
Scenario 3: $287.68 (credit card) + $1798.95 (loan) = $2086.63 for 30 months
then $287.68 (credit card) + $0 (loan) = $287.68 for 30 months

Which is best? That really depends on you and your life.

Scenario 3 shows that we saved the most money by paying off the low interest but high balance loan first, but Scenario 3 has a killer bill of over $2000/month in payments for 2.5 years but then it's practically a free ride the remaining 30 months because only the credit card payment remains and it is 1/7.25 or only 13.79% of that earlier $2000+ / month outlay. But, that $2000+ a month... Ouch!

Similarly, Scenario 2 in which we pay the credit card off first, then the loan, saves you a lot - almost as much as Scenario 3. However, your outlay the first 30 months is $1413.14 which is over $600/month less than Scenario 3's first 30 months. The downside is that you still have to pay $966.64/month for the next 30 months. But, you are still saving almost $450.00/month now because that's what you were paying on the credit card which aren't now.

Scenario 1 has the least pain each month, but it has the longest most expensive pain. Compared to Scenarios 2 and 3, you are giving the banks $4000 more. But, you have a very predictable payment of $1254.32 for 5 years.

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[abc3643]

=====
Many people in this case would opt for Scenario 1 because they have a tight budget and paying off debt doesn't bring anything new to the home. At the same time, Scenario 3, which saves the most, is a killer for 2.5 years. God forbid, you lose your job.

I'd go with Scenario 2 which is generally what I do anyway.
With Scenario 2 - paying off the high-interest credit card (but low balance compared to the loan) first saves you $4000 over Scenario 1 (paying it all off steadily) BUT there's a lot less pain those first 30 months. Furthermore, and this doesn't show up in the numbers. Unlike loans, credit cards are flexible with their payments. If you lose your job, you can pay the minimum until you are on your feet again. With loans, that's harder to do... You need to call the bank and negotiate (they might let you just pay the interest... for a while, not forever...) or, with them, you might "refinance" for a better rate, but that still costs money.

To me, credit cards are low-hanging fruit. Pay them off and keep their balances low. This helps your credit rating, but also is a do-it-yourself loan for emergencies. For instance, my car was old and in the shop. I often kept my credit cards at $0 because I was going to need them soon for the next repair... With loans, just keep making the payments and don't be late. Pay more or more often whenever you can.

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[abc3643]

=============
Believe it or not, I still didn't actually answer your question. I gave a debt example above, but the numbers for each group of debts are different.
You have:
A Pay them off from smallest amount to highest amount.
B Pay them off from highest to lowest interest rate.
Well, in my example, the credit card was both the highest rate and smallest amount. It was A and B.
But what if the loan was only $5000 and the credit card was $10000? In that case, definitely pay off the credit cards.

Personally, I like A because I want less payments. I'd rather pay 1 creditor $100/month than 2 creditors $50/month. Less headaches - and less total minimum payments. But I hate high interest rates because that's giving my creditor free money.

It really all boils down to this:
1. What are your total monthly payments from all debts going to be?
2. How much can you afford normally?
3. How much can you afford in an emergency such as unemployment or sudden extra debt like car repair or surgery?
4. How much do you want to save into a savings account or investments?
5. And, OPTIONAL, like I mentioned earlier, how many creditors do you want to deal with? The more creditors, the easier it is to forget to make a payment and the more you are being soaked across the month in a billing cycle. (It's easier to make 1 payment each month to a single creditor than 1 payment from the first paycheck to 1 creditor and then a different payment from the next paycheck to a second creditor.)

Look up loan calculators on the web and learn to use Excel or Google Sheets to compute stuff like I did above. I used to have a fancy Excel loan calculator that I built. If I can find it and you want it, I could send it to you. Finding it may be a problem though.

Good luck! And you can always PM me but let me know you are the author of this question first.

[Flower7]

Thanks so much for explaining APR in detail! I’ve never really understood how to calculate that. And great examples of the different scenarios! That made it very easy to understand everything and compare them.

And yes you’re right, in my poll, I was making the assumption that the debt with the lowest amount would also have the lowest interest rate. But it does change things if that’s not the case.

I agree that it makes things much simpler when the QUANTITY of bills is lower. Because yes, it can get hectic when bills are due on various random days throughout the month. That can also lead to late fees, which means paying even MORE money.

[abc3643]

@exitseven wrote "Highest to lowest interest rate. No doubt about it." There is doubt about it because that's not always - and not often - true.

The bottom line is how much does each balance grow each month.
Let's look at that debt problem I described above.
Credit Card Rate = 24% APR, so the per payment interest rate is 24/12 = 2.000%
Credit Card Debt = $10,000.
Loan Rate = 6% APR, so the per payment interest rate is 6/12 = 0.500%
Loan Debt = $50,000.

What we are going to do is look at how much each balance will increase if we made no first payment.
1. Start of Month
Credit Card Balance = $10,000.
Loan Balance = $50,000.
2. Interest Accumulated During the Month.
Interest Accumulated = Balance * (1 + Per Period Interest Rate As A Decimal)
So:
Credit Card Interest Accumulated = 2/100 * $10,000 = $200.00
Loan Interest Accumulated = 0.5/100 * $50,000 = $250.00

So, that's it... In this case, the loan, which has an APR of 12% is giving you $50 more new debt each month than the credit card which has an APR of 24%.

This says, in this case, pay the loan before the credit card at least for a while. Of course, you do have to pay the minimum on the credit card.

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[abc3643]

First, a correction.

I wrote:
Interest Accumulated = Balance * (1 + Per Period Interest Rate As A Decimal)

That's wrong... That's the new balance at the end of the first month.

This is the correct equation:
Interest Accumulated = Balance * (Per Period Interest Rate As A Decimal)

========
OK, back to the problem...

Suppose you just pay the interest on the credit card so the balance never goes up or down.

What does the balance on the loan have to be before paying the credit card is better than paying the loan?

We already know that the credit card is accumulating interest at $200/month.
So, what's the balance that the loan needs so it too is accumulating interest at $200/month?

Interest Accumulated = Balance * (Per Period Interest Rate As A Decimal)
$200 = Balance * 0.005
Balance = $200/0.005 = $200 * 200 = $40,000.

So, this tells you to pay as much as you can on the loan to get that balance down. Once the balance is under $40k, the credit card is what is hurting you more.

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[abc3643]

>>>> This is why this stuff is not cut-and-dry like your A, B poll suggested and I went with "C".

The situation changes all the time.

I just showed that it's better to pay down the low interest, high balance loan before the credit card, but, after a while, it's better to pay down the high interest, low balance credit card.

The nice thing is that your statements each month will tell you how much interest you accumulated that month. Look at it for all your debts and then pay on the highest ones first.

SO:
RULE: EACH MONTH, THE DEBT THAT HAS THE HIGHEST INTEREST ACCUMULATED THAT MONTH IS THE DEBT THAT SHOULD BE FOCUSED ON PAYING OFF.

Again, which debt that actually is may change from month to month.

And, of course, as John Lennon said before getting assassinated "Life is what happens to you while you are busy making other plans."

So, we may need to break these rules every now and then.

[exitseven]

you pay interest on the unpaid balance whether it is a credit card or mortgage. If you pay off the high interest rate first you will be better off because the interest rates are much greater. You will pay less interest the smaller the unpaid balance is.

[PeacefulRainDrop]

What I did was I paid $10 above the minimum payment for them all.

Then I picked one to focus on. I flipped back and forth with those two methods so I guess I created my own. Haha

If you have a mastercard with $1,000 on it minimum payment $10 and interest rate is 10%

If you have a visa with $7,000 on it minimum payment $70 and interest rate is 15%

I would put $80 on the visa and focus on the mastercard first and when that debit is gone put the money you were putting on your mastercard on to your visa.

Yes the larger interest rate will keep multiplying but I find if you focus on it it will take 7x longer than the other one. I find seeing my progress of getting one completely gone helped motivate me.

So bottom line I would put a little above the minimum payment on all your debt each month and the smallest one cash wise I would focus on. It definitely can be overwhelming!

Another side tip id consider look at your monthly expenses/spending habits and see where there is wiggle room. For example with me I was getting a monthly dog woof box.. yes its a great deal but it doesn't make life easier so I subscribed myself to the pet stores around me and when sales go on thats when I stock up on treats. I found a cheaper internet and completely cut cable (there are phone apps for free you can watch shows on like the bachelor (ette) city tv app = huge saving) also looked into my phone I was in a tv, internet and cell phone package with eastlink $132/month.. now internet is $70 and cell phone I switched to public mobile they have a plan thats $15 met all my needs yes 100 talking mins is touch when doing important calls but there's a purple textnow app that gives you a phone number for free you can call out as long as you have wifi. Besides that the rest of the cell plan was the same as Eastlinks that they wanted me to pay $50 for once I got rid of the other two services I asked if there was anything else they could do to make it cheapet they said no their current promotion was more money than what id be paying so I shopped around found public mobile and its treated me well.

If you sign up to public mobile (only Canada wide) using my referral code 7PRWQN you will receive $10 off your first month. If you tell a friend about it and they switch and sign up with your referral code your friend would receive $10 and you would get $1 off your payment every 30 days as long as your friend stays with them! Excellent company excellent service! I had service when bell and telus did not and they are better known you pay more money for them.

[PeacefulRainDrop]

If you have two payments that are less than $100 apart I would focus to pay off the larger interest one first.

I hope this helps!

[Flower7]

I really like the idea of just paying a set amount above the minimum for all the bills. Essentially focusing on all of them at the same time. That seems like a very helpful system. And cuts out a lot of decision-making!

And yes, it definitely can take a VERY long time to see progress when dealing with the largest amount.

I would have loved to use that phone company and your referral code for the discount, but I don’t live in Canada.

And yes, your answer definitely helped a lot!

[PeacefulRainDrop]

Yes your paying all the same time let me give another example.

Lets say you have debt of :
and all minimum payments $90 (easy to show realistically won't happen

1. $1,000

2. $4,000

3. $7,000

4. $8,000

Pay $100 2, 3, and 4 but since 1 is the smallest double it and pay $200 (if budget allows) then after 5 payments that will be gone. So your left with

2. $3,500

3. $6,500

4, $7,500

And an extra $200 a month since 1 has been paid off. So I kept 3 and 4 the same but paid $300 on 2. So in about 12 payments of $300 2 will also be gone. So your left with:

3. 5,300

4. 6,300

Then you combine the extra $300 to 3 so now that $400/month plus keeping at 4 the same way. In about 14 payments that one will be gone so then you pay down 4 with $500 until its gone.

Thats the method I tried to explain. That worked well for me. You may not be Canadian but you could shop around see if you can find a better rates.

Or make lifestyle changes like if you get a coffee every morning on your way to work here its almost $3 for one. Lets say you work 5 days a week. Those coffees cost you $15/wk and $66/month and $792/yr it costs just for your morning coffee. So you could wake up 10 mins earlier and make your coffee at home saving money same if your buying your lunch at work that adds up. The night before make extra for supper abd take left overs for your lunch at work.

[PeacefulRainDrop]

I dont think you fully understood what I was trying to say... its hard over text it be easier over the phone but I hope that makes more sense :)

[Flower7]

Yes, I see that you’re not only paying a set amount above the minimum of each, but also are doubling that payment on one of the accounts.

[PeacefulRainDrop]

I wish you the best of luck no matter which method you choose is best for you!

[NaultD]

Basic necessities including mortgage then higher interest loan. Sure mortgages tend to be the lowest intrest loans possible but your borrowing $100,000 plus with 3% intrest. That is nothing to sneeze at.

Next priority is credit card dedt. That's 15% to 28% over a few hundred bucks maybe a thousand. You will get eaten alive at that rate month to month. If you have multiple credit cards, pay the highest intrest rate card off first. It's basically bitting off the largest part of your ass. Then go down the line to the lower interest rates cards.

[Flower7]

Very detailed answer, thanks!

[Curmudgeon]

In absolute terms, the interest rate is paramount.

However, there is the psychological sense of progress and the thrill of removing, one by one, each creditor to pay off from your list, and while that is not mathematical, psychological motivators ARE real to many people.

[Flower7]

Yes, very true! Sometimes the motivation is more important than how much money is being saved on interest.

[victoriaxoxo]

You need to rid yourself of ones that charge highest interest rates because likely they are growing faster than you are paying them off. Leave the small interest rates ones for later although the amount will play a part as well. If the interest rate is small but amount is huge then that could hurt you as well. Calculate which loans are actually charging you the most in terms of actual sum and handle those first.

[Flower7]

Very true!

[GoodGuyBreakingBad]

Make an agreement with the debtors but never give them any debit card/banking information also when you send a payment, mail them a money order to them, never send any post-dated checks, if the debtors refuse to agree and want more money then don't send any payment to them, tell them you don't recognize the money they sent to you and it belongs to someone's name similar to yours, trust me I had Verizon try to say I owe a debt, well I sent them I don't recognize the debt and I never heard from them

[Outofthegrey]

Technically speaking you should attempt to transfer balance to the lowest interest rate or consolidate to a personal loan with a lesser APR, then leave the credit cards alone as you made payments against the total principal amount with the lower interest.

[AviatorTom]

It's really a balance, but the best way is to reduce the amount owed on the higher interest rate debts first while paying something towards the other debts. As a general rule, pay 2/3 against high interest debts and 1/3 against other debts, trying to pay off the smaller amount debts first. In business, that's called dealing with the "low hanging fruit".

[RedStiletto88]

I feel paying off the lower balances first is more effective because you can actually see the progress better

[Flower7]

True, it’s very easy to get discouraged when the goal is more far away.

[Ms_Vanderquack]

Depends, if you can pay a small one off that means there is no interest rate on it at all, and no interest is better than low interest. You might want to look into debt consolidation options though.

[Flower7]

I looked into debt consolidation, but decided against it because they charge a fee for their service. The last thing I need is ANOTHER bill!

[Ms_Vanderquack]

Yeah, it doesn’t always make sense to do. They are looking to make a profit after all. But not knowing the specifics of your financial situation it’s hard to give specific advice. As for general advice make sure you are hitting the minimum payments each month for everything. Do what you can to consolidate the debt yourself. If you can pay off a few smaller ones using a credit card, or if you can’t, pay off the smaller ones as quickly as you can. That way will have less interest over time and less individual payments to worry about making each month.

[Flower7]

True, those individual payments are driving me crazy! Too much to keep up with. Lessening the quantity of them would take away a lot of stress.

And good point that even if the interest rate isn’t as high, no interest is still better!

[Prettygurl12]

Mathematics say to do highest interest rate to lowest. Human psychology says smallest to largest.

[Prettygurl12]

You should look up Dave Ramsey and his baby steps.

[Flower7]

Interesting that human logic differs from the facts! But it seems to be true though. For some reason, I struggle with trying to tackle my largest debt first, even though I know that’s the one where I waste the most money on interest. My mind just doesn’t seem to accept that!

[Prettygurl12]

Paying them off smallest to largest gives you small wins. So then you get more determined to finish.

[Flower7]

True, those endorphin boosts along the way are very helpful!

[Aerissa_Jade]

I will do the smallest loan first and fastest, then apply that payment to the larger one. As having more than one loan is hard.

[Flower7]

Yes, having multiple bills can definitely be a hassle!

[Aerissa_Jade]

Yup, especially if something bad happens, like job loss... now you got multiple to worry about and multiple collectors harassing you.

[exitseven]

Highest to lowest interest rate. No doubt about it.

[Flower7]

That definitely causes less money to be thrown away!

[NathanDavis]

smaller ones first... especially if they're a few of them

[Flower7]

Yes, having too big of a quantity of separate bills can definitely get tiresome!

[NathanDavis]

yep, I just squashed a few of those... first days of January, now I am just focusing on the main one

[Static_In_The_Attic]

The other day one of my coworkers asked me the same question & he had a car loan & a mortgage & I told him Interest Rates is what it is all about & paying highest interest rate to lowest is the way to go.

[ChiTown33]

This isn't easily answered. Yes you would think highest interest rate first generally but I don't know what amounts we're talking here. The low interest debt could be huge in comparison to the high interest one. Project how long it's going to take you to pay down the debt. Figure which one will cost you the most over that time and attack that one.
The best decision is not to get into debt in the first place if you can absolutely help it.

[Flower7]

It’s a case where the lowest amount is also the one with the least interest. And the highest amount has the most interest.

[ChiTown33]

Well clearly pay off the highest interest one then.

[_no_one_]

Will be easier to keep tabs if smaller ones are paid off first plus it would bring in some confidence i guess.

[Flower7]

Yes, getting each smaller one paid off gives a sense of accomplishment along the way. And easier to keep up with also, if there are fewer overall bills.

[bigmatt98]

Whatever you can afford at the time but make sure yoyr always working toward paying it off at all. times even if you have to sacrifice luxury to do it.

[DaveToo]

Paying off the smallest first gives you extra for paying the rest.

[Flower7]

Very true!