Month: April 2010


A BEST WAY TO GET OUT OF DEBT?


Is one way better than another to get rid of debt? The answer to your question will likely differ depending on who you ask.

“FINANCIAL” METHOD. Nearly every “financial” person will advise that debts should be paid off in a particular order — start with highest interest rate and move to the lowest interest rate (done by rolling the payment from one debt to another as debts are paid off). While this method makes perfect sense from a mathematical point of view, more and more people are finding that there is another method [often overlooked] that works better for their psyche …

PSYCHOLOGICAL METHOD. This system of debt repayment, popularized by Dave Ramsey, is often referred to as the debt snowball. This method organizes one’s debt from the smallest balance to the largest balance. This method will not likely save the most money or time (as the interest rates are not likely to align in that manner), but many find this approach very empowering and motivating because they see progress quickly (envision being on a diet where you are seeing progress quickly … becomes much easier to stick with it). Focusing on the smallest balance first will accomplish this end by providing some quick victories.

In using either of these methods, pay the minimum amount on all debts except for your “focus” debt (smallest balance in psychological method; highest interest rate in financial method); pay as much as possible on the focus debt until it is eliminated and then approach the next debt in the list with similar intensity. As debts are eliminated, the debt snowball will get bigger and bigger.

I’m not arguing against the merits of the financial method as outlined above. Obviously, if someone has the discipline to adhere to the plan, you’ll save the most time and the most in interest expenses by following its tenets. The psychological method merely takes a seemingly more “human” approach to finances that suggests that people will be more likely to stick with their ‘financial diet’ if they see those ‘debt pounds’ coming off quickly. That is what Personal Finance is all about – doing what works best for you – which very well may be something different than the next person. The point is to get out of debt [the end]; don't get caught up in the means to the end. How you decide to do it is much less important than actually doing it!

PowerPay, a free online tool developed by Utah State University Extension will allow you to play around with both of these debt repayment methods. I wrote a detailed explanation of the PowerPay system about a year ago if you're unfamiliar with it




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