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Debt Reduction: Snowball Method vs Highest Interest First

debt reductionWhen it comes to personal finance, there are enough so called “experts” to make your head spin. It seems as though in order to be taken serious these days, you have to have some sort of gimmick that will enable your readers to get out of debt with little or no effort with as few painful sacrifices possible. Unfortunately for those that live in the real world, that is usually not the case.

The reason why most of these experts end up going away after a while is because their get out of debt quick schemes do not typically pan out. It is the same with the get rich quick authors that write one book and you never hear from them again. The truth is that they were the ones that got rich quick off the book.

So what does really work?

There are a handful of battle-tested methods that have stood the test of time to get people out of debt. The most popular are called the “snowball method” and paying the highest interest debt first.

  • Pay The Highest Interest Rate First

This method is pretty straightforward and most mathematicians will say this is the best route because it gets you out of debt with the least amount of interest paid. You start by writing all your debts down on a piece of paper and put the interest rate associated with each one on the side of the list. Next, you reorganize the list with the highest rate and the top, second highest at number two, and so on.

Every month you pay the minimum payment on each debt from the list and pile all extra money that can be found in the budget onto the item that is number one on the list. Regardless of the total amount due, you pay the highest interest first and go until it is paid off. Then you cross that item off the list and go to number two. Repeat.

The beauty of this method is if done correctly will get the debt finished with the least amount of interest. The downside is human behavior often gets in the way, and if the first debt on the list happens to be something that will take months or years to pay off, people can get discouraged and quit.

  • Snowball Method

This process is very similar to the one discussed above, but with one major difference: you order the list according to total debt amount, not interest rate. In fact, you ignore the interest rate all together.

Start by creating a list of debts with the correlating outstanding balance next to each entry. Then reorder the list with the lowest debt total at the top, second lowest at number two, and so on.

The instructions from here are just like when paying the highest interest first, you just pay the lowest debt total as number one. The thought process behind this method is that by getting some of the quicker, smaller wins (sometimes only a few hundred bucks that has been looming for a long time) people are more likely to get motivated and keep going. By the time and individual hits the last few on the list, they may take months or years to pay off but they will have readjusted their lifestyles and built a lot of momentum to help tackle those mountains.

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