Debt Snowball – Highest Interest vs Smallest Loans First

by David Ning · 44 comments

snowball
Mathematically, it’s obvious that paying off loans with the highest interests rate first makes the most financial sense but as you may know, some financial experts promote “paying off the smallest loans first”. Why do they do that? Let’s take a look today.

Smallest Loan First

The smallest loans first method is simple. Instead of paying off debt with the highest interest rates (ie, the ones with the least favorable terms), you put that aside and list out all your debt sorted by the amount owed. Then, you pay the minimum payment of all your loans each month and pile all other available income for debt repayment into the loan with the smallest amount outstanding. Once the first debt is repaid, you try to repay the second smallest debt you owe and so on.

The argument for this approach is that eliminating bills are so satisfying it will be easier to stay on track with the overall debt repayment plan. The positive and quick feedback will have a great impact on your commitment to repaying your debt and will overcome the increase in interests that you need to pay.

Highest Interest Rates First

With this method, sort your debt by interest rates. Then try to pay off loans with the highest interest rates first by paying the minimum payment of all the other loans. Once one loan is paid in full, rinse and repeat with the next one down the list.

The facts are undeniable. Paying off highest rates first saves you the most total interests. In turn, it helps you pay off your debt the quickest because more of your hard earned money is going towards principal reduction.

Which Debt Snowball Method is Better?

While the math isn’t in our favor, I believe the smallest loan first method works for the majority. Being able to eliminate one of our debt payments provides a huge psychological boost and for most people, positive encouragement is not only helpful but necessary. Without periodic encouragement, it’s very difficult to be disciplined enough to pay off all our debt.

I know that if I’m encouraged, I am more willing to do more. Therefore, being able to cross off debts may prompt me to save more, thereby allowing me to put even more towards my debts.

Sure the math doesn’t make sense, but Algebra (or is it Calculus?) in school never did either.

Want more ways to reduce debt? Here are 25 ways to pay off your debt.

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  • john says:

    I realize it is old but this is horrible, nonsequitir advice.

    If debts are very small (like a few hundred on a credit card) knocking them out first makes sense as it simplifies your life (paperwork). Similar to restructruing multiple loans.

    But if you are paying loans in reverse order because it is more *satisfying*, you are making demonstrably suboptimal financial decisions because of how it makes you feel. I thought the whole point of rational financial planning was to suppress and redirect that kind of thing?

    If psychological satisfaction is your goal, get some debt management/personal finance software that will visually quantify how much you are paying off over time. Break it down into charts and whatever. But ultimately it should DISSATISFY you to understand that you are paying off principle more slowly than you could.

  • Ryan G says:

    Paying down debt in order of descending interest rate is mathematically optimum. However, paying off the smallest debts first can give you much more financial flexibility to handle unexpected situations down the line. Flexibility can be worth a lot in helping keep you out of debt in the future. If you are running a tight budget to pay off debt and a truly unexpected bill comes along, it is going to be tough to deal with.

    I think there are a couple of other factors to consider when choosing which debt to pay first. One is the interest rate relative to the amount of debt. For credit cards, this ratio can be quite bad. So, even if you want to knock out smaller, lower rate debt first and snowball the higher rate debt later, consider knocking out any exceptionally high rate debt first no matter what, such as CC debt, payday loans, title loans, etc.

    The second factor I would consider is the monthly payment and the repayment terms. For relatively small student loans (under $20K), if you have 20 years to repay them and can fix the interest rate, you are better off leaving them for last no matter what. In fact, I’d advocate paying off your mortgage first. Student loans die with you if you pass away before they are repaid, and the monthly installment can be quite small. Paying them down quickly, while forsaking other debt, may not have the best payoff relative to how you can use your money.

    • Ryan G says:

      I’d like to clarify some of my statements… I suppose I’d pick a strategy for paying down debt that would focus on the smallest debt first within a group of debts of similar interest rates, say within 2-3% of one another. So, if you have high interest CC debt, pay it down first even if you have small balance, low interest debt that could be knocked out quickly. Within an interest rate group, pay off the smallest debts first to snowball the repayment while leaving yourself with some flexibility.

      • David Ning says:

        Good points to consider Ryan. The other good news is that CC debt tend to be smaller in nature too so for many people, the highest interest debt also tend in the group of debt that is smallest.

  • Diane Z. says:

    The method to pay off the lowest balances first is actually better for your credit scores than working on whatever single item that has the highest interest rate items. Credit scores are not calculated based on interest rates. Zero balances on open, available credit is desirable, making for a higher credid score. For instance, paying off three low balance items in the time frame you might pay off one high interest rate item is more desirable for future lenders / creditors looking at your credit. And, the higher the score, the lower the rate you would get on your next credit card, line of credit, mortgage, etc.

    • Matt says:

      People who are trying to become debt free are not concerned about their credit score, nor should they be.

      • David Ning says:

        Sure it’s low priority for those who are trying to pay down debt but having a good credit score can still be useful, like when you are trying to get the best cash back credit card since only the best borrowers (determined by their credit score) qualify.

    • David Ning says:

      Interesting insight. This can be true for those who end up lowering their credit utilization ratio. I would add that you also need to have a $0 balance, because using the credit card will mean that it’ll be showing a non zero balance.

  • Knowing thyself is the most important step in determining how to payoff debts. Both methods are equally valid in their own ways, in my opinion. Furthermore, I believe that everyone should strive to eliminate their debts so quickly that the method becomes a non-issue.

  • I assume paying off the highest interest rate debt is the best way to tackle this problem. But, when I was in debt I chose to payoff the smallest debts first. It was a mental thing for me. i just felt that I had accomplished more by seeing smaller debts disappear. Also, it helped me payoff the largest debts faster. Every time I paid off a small debt, that monthly payment would get added on top of the payment of the next smallest debt, and so on.

    • David Ning says:

      Feeling good about a strategy can be all that you need to accomplish the goal sometimes. Good for you to find what works for you!

    • KiwiKid says:

      That’s the whole idea. You have $x to pay off on your loans. When one is demolished then you add that extra amount that had previously been used for the highest interest rate loan to the next highest interest rate loan and so on until you end up debt free.

  • Luckily for me it worked out in my favor that my smallest loan is the one with the highest interest rate, so that’s an extra added incentive to get the smallest student loan gone first!

    • David Ning says:

      Ha good for you! Hack away and you’ll be debt free in no time!

    • KiwiKid says:

      Then you start on the next highest interest rate loan. Which is what the article was saying all along. Yet someone somewhere managed to munt it all and create an argument that paying off the smallest loan was better because you got out of debt quicker. Um, no you didn’t. You will ALWAYS get out of debt quicker by paying the highest interest rate loans off first. Always. No ifs. No buts.

      • David Ning says:

        It doesn’t make any sense mathematically for sure. All people are saying is that by making the debt payment process more encouraging because you are fewer payments faster, you will be more motivated to keep paying the obligation off.

        • KiwiKid says:

          David, I understand what you are saying. It’s all psychological and the people using this argument are, and I’m not trying to be rude here, but they are deluding themselves.

          If they were to total their debts and calculate how much they owe by paying off the smallest dollar amount loan even if it is the lowest interest rate, then do the same exercise but paying off the highest interest rate and comparing then they would see that it is quicker to get out of debt by paying off the biggest interest rate loan first.

          I’ve been there, done that. I know that it “feels good” to knock one of the bastards off… so one less loan to “worry about.”

          I’d suggest that if people want to see the reality that they download free software that shows how much you will pay off, how long it will take, and how much money you will pay to “the man.” Use that software to look at how long and how much interest total you will pay using different scenarios. And I know what the answer is… because I’ve used it myself, pay off the highest interest loan first. The numbers, well ya know, they just don’t lie.

          • David Ning says:

            Good suggestion on using some type of software to help you see progress.

            The math is math, so no one can dispute that. But do whatever works for you. Some people respond better with numbers, while others end up reaching their goal more easily if they get fired up about it. Do what works for you.

  • Paul says:

    It’s easy to be Anonymous and critical isn’t it?

    Is there a valid reason that they should not look to find ways to relieve themselves of this burden? I haven’t seen anybody ask for a way to stick it to the man and NOT pay what is owed. Have you?

    Were they irresponsible? Maybe, maybe not. Stuff may have happened where they needed money urgently. Which is more irresponsible? Not going into debt and letting someone die needlessly, or going into debt so that person can be saved/healed and go on to live a hopefully productive life?

    Brutally honest are you? Methinks brutally arrogant is more appropriate.

  • Anonymous says:

    You were irresponsible enough to pile yourself into debt, so why are you expecting help getting out from under? Yes, I am being brutally honest with you.

  • troubled with debt says:

    I have no credit card because I don’t make enough to qualify. I’m glad, actually! ???? But can I adapt the “debt snowball” to make it work for me? I’ve got my share of debts to pay, believe me!

  • Garry kerr says:

    Additional payments toward the Loans with the Highest interest, as well that you can do the smartest thing and pay the highest interest ones first.smaller debt tend to actually be the higher interest.

  • Scott says:

    I don’t believe that paying the smallest debt off first is as much emotional high as much as a cashflow booster. The reason is most smaller debt tend to actually be the higher interest. For example: a department store credit card usually is 15% or higher interest but people tend to only carry about 5k in debt. A student loan is only 4%-7%, yet varies between $20k and $120k! So my question is does the debate that the article makes really matter?

    My focus would be more about what debt payoffs can be expedited to improve budget cashflow. The faster you pay off smaller debts, the cash used for those monthly payments are now surplus to “snowball” or add to the next debt payments on larger balances (the ones that really stress everyone out).

  • Great article! I totally agree that the “Smallest Balance First” method is better. I know from experience that it is very motivating to get those first few debts paid off and get the momentum you need to get the bigger ones paid off later.

  • FYI says:

    Think of each loan as a savings account – with a negative balance. If you had a savings accounts with different rates, which would you prefer to make a deposit in? Probably the one paying the highest rate.

  • Matt says:

    It is extremely scary that you people are debating which strategy is better. The goal is the become debt free in the cheapest most efficient way possible.

    The “psychological gains” could just as easily be argued to be “psychological losses.” What if paying off a debt quickly made you justify going back into debt just a little as you know you can pay it off quickly? This whole “psychological” argument can go both ways, which is why it’s beyond stupid.

    The bottom line is this: Paying off your highest interest debt first is always the quickest, cheapest way of becoming debt free.

    The other way is like going on a diet and then visiting mcdonalds everytime you lose 10 pounds. How is it not?

    • Sam says:

      That doesn’t make any sense. This isn’t saying that you bing after paying off your smallest debt. The theory is that you pay off your smallest debt, have the psychological benefit of feeling like you accomplished something and then using that money to pay off the next smallest debt. It doesn’t say pay off the smallest debt and then get more debt. Where did you read that?

    • Scott says:

      What if the lower interest debt had a monthly payment that put you out of budget? What if you didn’t have cash flow to deal with higher debt regardless of interest?

      I don’t consider the debate to be an emotional issue. If paying off smaller debt helps with cash flow for the larger debts, then what does it matter.

      Another point; isn’t it odd how higher interest debt is usually lower in balance? Department store cards are high interest but limits are usually no higher than $5k. mortgages or tuition loans are low interest of 4%-7% yet can cost $50k or higher. I think the debate is a moot point…start with the lower debts first and develop better cash flow for high debt pay-off or build an emergency fund.

  • gino says:

    Everyone is different, and I agree that a positive influence will keep a person on track. But I think we all need our own financial plans. There are companies that can help with that and give proper counseling to get rid of debts.

  • Jake Adducci says:

    I just did a calculus project on this very topic. You have 3 loans, Loan A $150,000 @ 6% for 15 years, Loan B $15,000 at 5.3% for 5 years, and Loan C $6000 at 6.5% for 10 years. Your grandmother passes away and leaves you $100 every month for the rest of your life. Which loan should get the $100 first? The Largest Loan, the smallest Loan, or the Highest Interest? After hours of calculating, I found out that the Highest Interest saves the most money. If you place the $100 in additional payments toward the Loans with the Highest interest, then, after paying off that loan, using that loan’s payments (plus the $100) toward the next highest, I was able to save (in this situation) $37,991.37 . In conclusion, I would support the Highest interest loan, being the interest continually is stacking, you must pay it off.

    • FYI says:

      It took hours of calculating to find out that paying off the highest interest loan first saves the most money? That doesn’t even take calculating to figure out.

      Think of it this way: Each loan is a savings account with a negative balance. Which savings account should you deposit your money in? The one paying the highest rate (charging the most interest).

      • Paul says:

        A loan is a savings account with a negative balance?

        As Mr Spock would have said, “Totally illogical Captain, totally illogical.”

        And, not necessarily correct. If you had a small balance at a lesser interest rate than the highest rate, it can in “some circumstances” be more favourable to pay that off first and THEN dump your remaining payments on the highest rate. And… take note, in SOME CIRCUMSTANCES, but not necessarily all.

  • Horlic says:

    For me, I will choose highest interest rates first. My main focus is to save as many as possible.

  • I posted on this topic a while back, and essentially I think you need to do whatever works best for you. Dave Ramsey himself even says that ” you can’t go wrong getting out of debt”. So just start doing it one way or the other, and get out of debt.

  • Ken says:

    I have always operated this way…smallest to largest. Getting those early wins builds momentum.

  • jay says:

    I like the momentum gained by paying the smallest loans first, but I also like the idea of eliminating several accounts quickly in case you run into a financial crisis. If I were to be laid off from my job, I probably wouldn’t be able to keep all my accounts current. I’d rather have to deal with calls from 7 companies instead of 14. Even if I never get laid off, I’d like to simplify things as soon as possible. Keeping track of fewer debts is easier and can reduce stress.

  • tom says:

    Paying down the smaller amount actually gives you momentum and that sense of achievement so you are more motivated to keep going and pay off the rest.

  • quick loan says:

    I like the smallest loan first method as well because it frees up a little more cash quicker to work into the snowball. It also really does help psychologically to get something taken care of.

  • Eric J. Nisall says:

    There is always debate about this type of issue, and here really is no best way to go about it, as long as the debt is being paid down.

    My personal viewpoint would be to keep additional interest from compaounding, so the highest interest rate is what I would target first and put most of my resourses toward. Some people may feel that if they can erase a small debt completely even though they will incur more interest from other labilities that it will help them psychologically, and that’s fine too. However, they will be staying in debt longer with that type of mentality, but if it happens to help people sleep at night, then I could not fault them.

    I wrote about something similar that perhaps will better explain my view called

  • marci says:

    In the past I did a combination of the two. Knowing that it was cheaper in the long run, I’d try to pay the highest interest one off first. But… if there was one that was closer to being paid off, I’d jump on that one first. Say I’d had 6 things to pay off – I’d keep on the highest interest one, but also pay attention to the closest one to pay off and put extra on it.

    There was not just a psychological boost in getting that lower one paid off – there was a cash flow boost…. the money from not having to pay that little one anymore could go toward the big one. Plus, in lower income times, it was just making things easier on the cash flow needed each month. Therefore, my way was a seesaw back and forth. Worked for me – debt free and intending to stay that way 🙂

  • Mike says:

    I really struggle with this one, since my mathematical mind tends to always win the argument. I understand the psychological benefits of paying off small loans and if it’s a choice between paying off small loans first and just making minimum payments, clearly paying off is better. If the goal is to get out of debt completely, then doing so as quickly (and inexpensively) as possible is the way to go. If you can become disciplined enough to pay more than the minimum on any loan, I believe that you can do the smartest thing and pay the highest interest ones first. Track the money you’re saving (or how much faster your debt is going away) by paying the highest interest loan first and you’ll have all the motivation you need.

  • W. Jackson says:

    I have read Money Makeover and for me it is easier to pay off the lowest loans first. Being able to see what you have done is better then only paying for the highest loans. Making a chart for my debt payments has helped me. I like seeing what I have done and knowing that financial freedom is on the way.

    W. Jackson

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