You have finally decided to tackle your debt and pay it down before it gets out of control. What's your best strategy to become debt-free? According to a study published in the Journal of Consumer Research, the "snowball" method was most effective in helping debtors pay down their debt.
The snowball method has more to do with psychology and momentum than it does with finance. By reinforcing that you are making progress on your debt, it gives you motivation to continue on the same track and make even greater progress.
As reported in the Harvard Business Review, the study began with a simple finding. In reviewing how 6,000 debtors addressed their debt, the researchers found that debtors concentrating on paying down one debt at a time reduced their debt further than those dispersing their payments equally over all debts.
By applying minimum payments to all debts except one and applying all extra funds toward eliminating one debt, debtors received a psychological boost from the amount of progress made against that debt. With equally dispersed payments, it's easier for debtors to fail to see the light at the end of the tunnel and slip back into poor spending habits.
Which debt should you choose to address first? From a purely logical standpoint, the best approach is to focus on the debt with the highest interest rate first. You will minimize the buildup of interest charges and reduce the overall debt by the greatest amount.
The snowball approach uses a slightly different philosophy: you attack the smallest debt first, paying only the minimum on all other debts. When that’s paid off, you try to pay off the second-smallest debt, still paying the minimum on the rest. You eliminate some debts in a short time, and those small victories give you the positive reinforcement that you need to tackle the larger ones. Effectively, you are trading off extra interest charges for an increase in willpower.
Is the snowball method the best method for you? That depends on the distribution of your debt, overall financial situation, and your personality traits.
With the highest level of discipline and resolve, and the income to reduce high-interest debt relatively quickly, it may make sense to approach high-interest debt first. Explains millennial money expert Stefanie O'Connell, "…in the debt avalanche you use the reverse strategy to pay off the debt with the highest interest rate first. Now, the thing about the debt avalanche is that it actually makes more sense financially because you want to get rid of your high-interest-rate debt. But the argument for the debt snowball is that you will be able to pay off your debt faster and so because of that you start building momentum and it's more of this psychological boost to finishing your debt repayment journey."
If a lack of spending control put you in a high-debt situation in the first place, the snowball method may make more sense for you. You need the satisfaction of wiping out any debt quickly to stay motivated and focused, no matter how small that debt may be — and this study suggests that you have plenty of company.
Consider any special factors that may change debt priorities. For example, if you are dealing with a debt repayment where there can be legal consequences (such as child support payments or debts to the IRS, that debt must take precedence. Also, if the difference in your high and low interest rate debt balances is small but the difference in the corresponding interest rate is huge, it may make more sense to attack the high-interest-rate debt first.
As you start to pay down your debt, remember that no debt repayment method will work if you don't bring your spending under control. Otherwise, you will have no extra funds to apply toward any debt. Review your budget and trim it where possible (and if you don't have a budget, create one ASAP). This will help you to prevent impulse purchases and maintain the discipline necessary to reduce your debt load.
The snowball method may or may not be the best method for you, but the important point is to get out of debt by whatever means works in your case. Follow the example of others and resolve to join the debt-free club in 2017. It’s not too late to make financial resolutions for the New Year — and, of course, a budget.
Try the free Debt Optimizer by MoneyTips for help with reducing your interest payments and lowering your debt.