Focusing on paying off your smallest debt first has proven advantages -- but researchers say there's a hitch.
What is the best way to pay off credit card debt? It’s an age-old personal finance debate.
One commonly cited method is to pay off your smallest debt first and work your way up to the largest debt last, a method known as “snowballing.”
As we explain in “How to Pay Off $10,000 in Debt Without Breaking a Sweat”:
The snowball method can be advantageous in that you quickly see progress, which might better motivate you to continue chipping away at your debts.
The value of the snowball approach has been debated. However, recent research out of Boston University’s Questrom School of Business explains there is a psychological benefit to snowballing that causes it to pay off financially.
Questrom researchers analyzed three years’ worth of monthly credit card data for nearly 6,000 indebted consumers who had an average of 2.5 credit card accounts.
They found that focusing on paying off one debt at a time was more effective than dispersing payments across all debts. Their findings were published late last year in the Journal of Consumer Research.
Researcher Remi Trudel, an assistant professor of marketing at Questrom, notes in the Harvard Business Review that study participants who concentrated on one debt at a time repaid debts 15 percent faster and worked harder than participants who spread out repayments across all their accounts.
Trudel explains this finding — and the value of the snowball method — in a Questrom School of Business news article. After testing a variety of hypotheses, researchers found that it is not the size of repayment or how little is left on the card after payment that most impacts how an individual perceives progress.
Instead, what counts is what portion of the balance the borrower succeeds in paying off. Trudel says:
“Thus focusing on paying down the account with the smallest balance tends to have the most powerful effect on people’s sense of progress — and therefore their motivation to continue paying down their debts.”
There’s a possible hitch to the snowballing approach, though. If your debts have different interest rates, you will ultimately save money on interest by focusing on paying off the debt with the highest interest rate first.
Trudel acknowledges that the snowball method is best only “to the extent that a consumer’s debt accounts have similar interest rates.”
So consider your debts’ interest rates when weighing the advantages of snowballing.
Tracking spending is key to debt reduction
Whichever approach you take to tackling debt, it can help to use a website or app like PowerWallet that automatically tracks your spending. Money Talks News founder Stacy Johnson considers this the best way to find the money to destroy debt.
In “Ask Stacy: What’s the Single Best Way to Pay Down Debt?” he explains:
Tracking your expenses is like using a map: It allows you to instantly see where you are, how close you are to your destination, and the speed at which you’re approaching. It keeps you focused to avoid getting sidetracked. It allows you to see roadblocks — wasted money — that are slowing you down.
Which debt repayment methods have worked best for you? Let us know by commenting below or on our Facebook page.