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But then I realized that they do make sense for people with a certain mindset. Not to be offensive, but that mindset is not a logical, orderly, or deliberative mindset. The snowball probably works well for people who are deeply in debt from out of control spending and lack of financial discipline.
So for those people who are going to backslide and return to an undisciplined approach to money unless they see the concrete result of paying off one debt in full very soon, I suppose that's a great approach. I see it as a proof of concept situation for people who aren't yet able to look at their finances from a strictly logical and efficient perspective yet. Better that (less efficient) method of debt reduction than no method at all, right?
Also, I am not rolling my mortgage or student loans or car into this. I guess I see the mortgage and car loan as a secured loan....so I'd rather pay off the unsecured debts first and then worry about the rest. It could also be because the interest rates on those are typically lower than a credit card anyways.
Also, one final thing. I would recommend that people doing this actively look for 0% balance transfer cards. This will ONLY work if you can chop up the remaining cards and be strong-willed. I just consolidated $20K of my credit card debt on a 0% interest card and am saving about $200/month in interest alone.
Well, clearly it's not, or this would work for everyone. Why does it bother you that people choose a non-mathematically optimal route to getting rid of debt? Just be grateful that you are one of the people who find spreadsheets and numbers interesting and motivating, and try and encourage others to work on it whatever way works best for them.
If someone wants to use the "debt snowball" method, it doesn't bother me one bit, as long as they understand that it is neither the fastest nor the cheapest way to use their available funds to get out of debt.
Twigger: Good point about your minimum payments -- they do change as you pay down your debt so you'll have to be mindful of how much you're sending to each debt account each month. Congrats on your progress!
Kate: the undisciplined approach does not lend itself to paying off debt. If you're serious about paying off debt, I believe it should be done efficiently. A slight change from the popular "debt snowball" method can make a big difference.
What I mean to say is: people get into these positions because, to them, math doesn't motivate, having something in their hands that they can see, that motivates.
For these, Dave Ramsey is right on. Ramsey takes into account a "mindset shift" that has to take place. You don't simply say, "This is better because it's mathematically smart--let me get out my spreadsheet and show you."
First things first: people have to experience themselves impacting their own circumstances.
With the debt avalanche method, your first "small success" (defined by paying off a debt account fully) could take place at the same time as it would with the debt snowball method, if your smallest debt also has the highest interest rate. So it's possible that the first small request would come as soon as it would otherwise, rendering the "benefit" of the snowball method irrelevant. But in the chance that it doesn't, redefine the first "small success" to be a certain dollar amount, say $1,000 total paid off across all accounts. A milestone like that can be a motivational factor as well as anything defined by the snowball method.
I understand from personal experience how different things motivation different people and things like this should be tailored to the individual's needs. If it is *explained in plain language* to those wishing to pay off debt that it is more expensive and longer to use the debt snowball method, there is only one obvious answer. Then, if motivation is an issue, and if the time before the first full debt repayment is drastically altered by the method chosen, redefine your small successes to be milestones. This can be designed in such a way to be motivational to those same people who were motivated by the first full debt repayment.
People are smarter than we give them credit for, even if they've found themselves in debt. Professing the debt snowball method is like a teacher instructing the entire 25-student class based on the needs of the one student within the class who is the least able and most reliant on hand-holding to perform a task.
One time my husband and I were listening to Dave Ramsey. He said, "Who is this guy? He's such a d-bag to his listeners." I told him who he was and that the reason he is so harsh is because his listeners are desperate and need to hear this in the maner he delievers or else it won't hit home with them. That's who guys like Ramsey are geared towards - those who are desperate, and need a quick approach, which may not always be the smartest.
As I mentioned, the "emotional" response to a quick success can also be achieved with the debt avalanche method by redefining milestones. But if your debt reducer can't see the big picture and choose the faster, cheaper, better option of the debt avalanche method, then they haven't learned to separate money from emotions or to make intelligent decisions about their finances... and thus, they have a higher chance of ending up in debt again.
That's why the debt snowball method is so popular -- it "answers" the exact question that listeners have when they finally decide to tune in and change their life. Unfortunately, it's not the best answer.
here is another catch that people just won't do. You NEED to change your lifestyle. Whatever lifestyle you were sustaining got you into this horrid mess. If you don't let go of the lifestyle then no snowball or avalanche will change things. You need to cut back expenses, and somehow make more money in order to get out of debt! That is just plain common sense.
I love the name "Debt Avalanche". This applies very well to my brother-in-law when my wife and I helped him snowball his debts. He actually had a Chevy Avalanche that was a large portion of his debt. Once we dropped that baby it was only a couple more months before we had him on "easy street".
regards,
ben
What he does say though is that it works better in action because a lot of people who have gotten into debt aren't there because they're good at math. They're there because they've made lousy financial decisions and life choices (in most cases - i realize some people are there because of medical emergencies, etc). They've spent money emotionally, and haven't made wise choices. Chances are unless you give them a method that takes into account the emotional side of spending, they aren't going to succeed.
Having the small boosts from paying off smaller debts gives the momentum that a lot of those people need to continue down the path of paying off their debt. If instead they're paying off the higher interest, and possibly higher balance debt - it takes longer, and the results don't come as quickly. When they don't see the results often they give up on making the payments because it doesn't feel like they're making headway.
Personally we're out of debt so thankfully we don't have to deal with this. I think if I did have debt I would probably do things your way - but that's because I'm more into numbers and keeping track of our finances. For most others - I think Ramsey's method will probably work better.
It reminds me of weight loss - the most successful programs emphasize incremental changes and intermediate goals. When a person has 100 pounds to lose, it's easier to focus on the first five instead of the next 95.
At first I believed the "debt avalanche" method was the best way to go. Then I realized that people who follow Dave Ramsey's suggestion may have a point. Later, I came to the conclusion that the positive aspects of Dave Ramsey's plan can be applied to the "debt avalanche" by looking at the milestones slightly differently as I've mentioned above. Not only that, but the "debt avalanche" method emphasizes separating emotional thinking from rational thinking, which is a good thing for those who have a habit of finding themselves in debt.
When dealing with money, the best option is to put your emotions and ego to the side and accept that the best answers are always the mathematical answers. And yes, this is coming from someone who understands quite a bit about psychology. Not everyone is motivated the same way, but various motivation techniques -- the same ones that work for the "debt snowball" method -- can be applied to the "debt avalanche."
So if you're serious about reducing your debt, there is no reason NOT to take care of it the most efficient way possible. You can be successful with either method, but if you want to save money and time, and if you want to prove to yourself that you can make intelligent decisions about money, do it the right way, the way in which you'll pay less interest and finish faster.
There is a time and place for the psychological aspects of money management, but this isn't it, just like it's a bad idea to buy or sell stock based on your emotions.
It isn't always so easy for a credit addict to do as you ask though "snowballing" gives them the instant gratification that got them into trouble in the first place. It's taking the flaw and making it work for them. As someone already said, whatever works to help you get straight.
It is not what you call it that matters...what is important is that you are making an effort to reduce debt.
With both methods you are paying the minimum on all debts EXCEPT one which is targeted to receive a higher than the minimum payment. When I was first learning about debt snowballs I was told this was the basis of dealing with debt.....the choice comes when you decide if to tackle the highest interest first or the lowest balance first.
Different things work for different people and according to my financial situation I have switched from one method to the next. Sounds like you are just calling the same thing a different name here. Same principle.
The key to debt reduction--under any name---is intensity.
Jesse: Thanks! I've updated the article to include thoughts about milestones.
"We are more concerned with modifying behavior than correct mathematics.... I have learned that the math does need to work, but sometimes motivation is more important than math. This is one of those times." -Dave Ramsey
Your argument is presented, but your readers shouldn't accept that "if your debt reducer can’t see the big picture and choose the faster, cheaper, better option of the debt avalanche method, then they haven’t learned to separate money from emotions or to make intelligent decisions about their finances." Your highest-interest-rate-first method is mathematically superior (and that's not a consession, it's a fact made by plenty of bloggers way before you), but an intelligent decision for EVERYONE is managing the individual's behavior. Some might do best with this method, some might do best with Ramsey's motivation, some might do best by building up a cash reserve before tackling debt, some might do best by paying off secured debt before unsecured debt. You shouldn't mislead your readers into thinking they're retards that will always be in debt if they can't figure out how to pay the high interest rate down.
One personal example is on a recent trip to Canada I made a dozen or so purchases in a weekend. I managed the exchange rates OK, but the bank charged me a currency conversion fee which made me overdraft my account (and if you tell me I should've memorized the fee schedule, I'm going to kick you in the nuts). After this hit, I had a necessary vehicle expense which I couldn't pay, and had to put it on my credit card. Because I'm not a robot and have a dynamic financial situation, I found it best to build up a small cash reserve in checking at, *GASP!*, 0% interest. Guess what! I don't pay overdraft fees anymore, and I've completely stopped adding any additional credit card debt. At a card interest rate of 10% and an overdraft fee of $35, it's MATHEMATICALLY better for me to hold $300 for a year as cash at 0% than to put it toward the debt, and I won't expand my total debt if any unexpected expenses of less than $300 show up.
To your readers: your most intelligent decision is whatever gets you out of debt, period. You're plenty intelligent if you can simply accomplish that goal, and not try to follow a plan that doesn't work for you that could theoretically save you $75 a year in interest charges. Take his advice, keep on reading, and do what's best for you. (you genius, you)
I love that.
It is mathmatically superior to pay off higher interest debts first. It is also mathematically superior to not have the debt in the firstplace....or is it. I mean, mathmatically why pay off any debt whose interest rate is lower after taxes than an alternative retun on investment.
What about the opportunity costs of this mathematically superior way. It makes perfect sense with standard stepped debts, but what about odd situations.
Say I have a mortgage at 7% for $500,000, a car loan at 8% for $50,000 and 20 credit cards with an average rate of 5.99% and an average balance of $2,000 each. (don't laugh, I have seen it)
According to mathematics, I should be paying off the mortgage first. Great. Now I get to pay on 22 separate debts, track them, reconcile them,etc for the next 20 years because it "mathematically" makes the most sense.
Your thesis for"mathematics" fails to consider the most important of issues regarding personal finance. RISK
No one ever give risk enough weight. Not paying off revolving debt cariies risk. juggling several debts carries risk. All debt carries risk. The interest rate is A factor, not THE factor. Balance is A factor. Risk is also a factor. Risk of rate changes, universal default,etc.
The best way to eliminate debt is to pay off the RISKIEST debt first. Sometimes it is the one with the highest payment, sometimes the highest interest rate, sometimes the highest balance.
You must also consider life situations. If you are trying to reduce your debts to qualify for a better rate on your new home purchase, lenders care about your MONTHLY debt obligations,not your TOTAL outstanding debt. Paying off a low interest (5%)car loan with a $700 monthly payment will make a much larger impact than eliminating a 20% $4,000 credit card balance. If that car payoff gets you a .25% better interest rate on a $200,000 mortgage, it is "mathematically superior" to pay attention to your own situation and pay of the loans with RISK.
Rock on!
Besides, someone with that kind of debt load would have to make more than 200K a year to come close to being able to pay the amounts you listed. Your example was not well thought out or very realistic. Also, even if you did choose wrong and focus on the mortgage, the minimum payments on those credit cards would have them balanced to zero before the mortgage was paid (in just over 10 years.)
1IRS
2 student loans
3 then your 1st
Thank you, your post was very useful to me.
Timmy
The logical approach will only work if people make emotional connections to it and break their other emotional connections to spending and saving.
Starting with small wins first, the snowball method appreciates the human element in this. It understands that most humans are driven more by emotions than by logic.
Awareness: "Rational and logical" and "emotional" are not mutually exclusive. Even people who are motivated emotionally can begin to understand the necessity of rational thinking in certain circumstances. In fact, they'll need to if they wish to address underlying problems rather than just treating the symptoms of debt.
Also, I've already addressed the emotional aspects. There are ways to make the Debt Avalanche "work" emotionally as I wrote about above, without sacrificing the extra time and extra money required by other methods of prioritizing debt.
In some cases, people get into unmanageable debt due to *poor decision-making* which they rationalize by saying "I'll pay it off later" or ignoring the consequences. Choosing a method that takes longer and is more expensive to pay off that debt, once they are ready to do so, is another case of *poor decision-making* rationalized by saying various things like "I'm motivated emotionally" or "Dave Ramsey says it's OK." Yes, even "emotionally-motivated" people "rationalize" their actions and decisions. (In some cases, people get into debt for reasons not related to decision-making at all, and that's another issue.) You can be driven by emotions, that's fine, but you can't change your mindset about debt until you begin to think logically about money.
I set up one which I am very proud - where I combined your logical thinking with the debt snowball. I put one CC which had the highest interest because I knew getting that off was priority #1 - then applied the debt snowball method.
Like most things in life - there are shades of gray.
The reason I find it difficult is because this means I keep my current budget with a relatively slim margin, which means saving up for anything I want (such as that new bed you recommend) takes a long time because of the slim surplus. I get frustrated and out comes the credit card. If I pay off one of the smaller debts, I get to that larger surplus much faster, and maintain my discipline in saving for what I want... which as some psychological rewards of its own. I paid off all of my credit cards and am now wavering once again between whether I should pay off my car first or go for the big kahuna straight off. To help me make a better decision, I've started to bucket my debt payoff at ING so it can collect a little interest while I decide. Of course 3% (before tax on interest) is definitely less than either the car or mortgage interest lost, when I do take that bucket and dump it on a debt fire, I feel good about the decision and the process to get there.
(That and my stupid mortgage company charges $10 to make extra payments online. So I build up large chunks before making the payments.)
You're right- absolutely. But you're a serious person who is capable of assessing consequences in your mind using a long-term, beyond-tomorrow-and-the-next-paycheck point of view. A lot of people are simply not serious about their finances.
There are plenty of adults who do not have the emotional maturity and personal discipline to make a PF decision based on the best fiscal consequences for themselves in the long term. In short, they're children with jobs, mortgages, credit cards, and debts. These folks NEED Dave Ramsey to yell at them and play psychological tricks on them to break down the mental trap of "if I just don't open my statement I can pretend the problem doesn't exist."
Some people who go through the Ramsey method begin to wake up from their PF nightmare and realize that the snowball method is costing them more than the avalanche, and switch. Most of the rest of them don't, and need Ramsey's methods.
You say that most people are smart. Then once they realize that the big interest rate is the dragon they want to slay (and your strategy is my own personal strategy that I thought up without asking anyone, and I'm just a girl...) then everyone's happy.
Your attitude is that he's an ineffective guy and maybe even borderline destructive. What's destructive is people disagreeing over when, how, and whether they should get out of debt. Divorces happen because people won't get on board and agree to get out of debt. He makes people want to be the one who gets on the radio and scream that they are debt free. I wish Governor Schwarzenegger would have been smart enough to listen to Dave Ramsey's stupid snowball idea.
So, go ahead and criticize his inferior idea. We can all start calling you "Betamax."
1) Depending on when you got student loans and when you consolidated, the interest rate could be higher than interest rates on other debts (I have college students who have graduated in recent years with student loans with 12% interest, for example. My husband consolidated his monster loans at...8.25%. Mine, I consolidated at 3.5). But...the interest rate (usually) doesn't change, forebearance/deferral are possible in case of job loss (not true with many other kinds of loans), and disability can cancel out part or all of the loans. I think getting out from under credit card debt even at lower interest rates is always better.
2) How much of the debt is to family/friends? Even if the interest rate is low, you might be better off paying this off early to square things with people.
3) Emergency funds: Having blown through our poor little baby EF TWICE in one summer (an appendectomy and a new unplanned-for roof), we've decided a larger cushion (more than Ramsey's $1000) is necessary before we tackle the student loans. But we also have extremely secure jobs, so that tempers things a bit.
Total interest paid isn't everything. Greater flexibility to manage expenses is quite valuable, especially with today's job market. With the possibility of kids and other unforeseen family expenses, I figure we'll end up taking our sweet time to finish off our student debt for good.