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Paying Off Low Debt First
You have probably heard the tried and true theory that the
quickest way to pay off debt is to pay the highest interest bills
first. There does come a time however when it is feasible to pay
off smaller bills first particularly certain credit cards with
high minimum payments. For example let's suppose that Johnny has
been building credit card debt on four separate accounts and now
has the following accounts. Leaving aside the option to transfer
funds from his higher interest cards to the lowest, for another
article when I can devote more time to that particular topic, let
us examine the possibility of reducing Johnny's debt.
| Account |
$ Amount |
% interest |
min. payment |
| A |
$3000 |
16% |
$60 |
| B |
$2000 |
15% |
$40 |
| C |
$300 |
13% |
$20 |
| D |
$700 |
15% |
$20 |
Supposing that Johnny has come up with $250 a month to use for
debt reduction, it would actually be better for him to pay off
credit card C first and then use that extra $20 a month to help
pay off card D next. This will have credit cards C and D paid off
in 4 months and now he is paying off his highest interest account
A with an extra $290 each month. This makes sense only because the
C and D accounts have high interest themselves.
If account D was only 10% interest it would not be better to pay
it ahead of A or B. The length of time required to pay off the
smaller debts is very important as well. If account D had more
than just a few months of reduction payments on it, the money
would do more work to tackle the large A account first.
Paying off the higher interest rates is the best way pure and
simple because you save interest by paying on $250 less the next
month, but if you have a few small debts that can be tackled in a
few months, and in particular if they have higher minimum
payments, paying them off first is a great alternative.
The reason that this can be good is that it gives a sense of
accomplishment. We are an instant gratification society, and even
though he will save over $1000 in interest by paying off account A
first, Johnny does not feel that he is accomplishing anything
until he is writing one less check per month. Paying off account C
so soon makes Johnny feel good that he is getting his debt under
control (and thus will continue to pay down debt and not give up
on the strategy). Then when he is working with that extra $20 to
use on the accounts with larger dollar values attached to them,
his confidence is again boosted.
Adding a car loan to this increases the complexity drastically.
Auto loans are typically lower interest than credit cards, but
have much higher monthly payments. These higher payments mean that
paying this loan off sooner could double the amount of monthly
funds that Johnny has available to knock out that credit card
debt, but paying that money on the much higher interest credit
cards instead reduces the interest paid over the length of the
credit card repayment schedule and is the best alternative. Unless
your car loan has a high interest rate, it is best to pay that
extra money on credit card debt than it is to double up that car
payment.
As for mortgages, the overall amount of the loan is so large, and
the interest rate should be low enough to make this the
final step of the debt reduction process, in my opinion. Once the
credit card debt is paid off, the money can then be sent to pay
off the mortgage quicker.
THIS CONTENT IS FOR INFORMATIONAL PURPOSES ONLY. THIS IS IN NO
WAY GIVING ANY LEGAL ADVICE OR REPRESENTATION. THE INFORMATION
CONTAINED HEREIN WAS COMPILED FROM VARIOUS ARTICLES. FOR ANY LEGAL
ADVICE OR REPRESENTATION SEEK YOUR OWN LEGAL COUNSEL.
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