When you have multiple debts you’re trying to repay there are a few ways you could approach becoming debt-free:
- A bit extra on each of them?
- Smallest balance first?
- Largest balance first?
- Highest interest rate first?
Which is the best way to make extra repayments?
For many years as a financial planner, I advised people to concentrate their extra repayments on the highest interest rate debt first, so they saved the most interest.
Once that debt is fully repaid all the repayments are then directed to the next highest interest rate debt, and so on. This method is referred to as the ‘debt avalanche’.
Mathematically that may be correct (which is why licenced advisers are obligated to recommend it) but it may only be effective for motivated and disciplined people.
What if you need motivation?
Behavioural research has shown that having a sense of progress helps motivate us to persist.
A 2016 study1‘Repayment Concentration and Consumer Motivation to Get Out of Debt’, Kettle et al, 2016 into how this applies to debt repayment found that people were more motivated to repay their debts when they:
- Concentrated extra repayment onto one debt
- Started with the smallest balance debt first
- Once repaid, cascade the repayments on to the next smallest debt
This method is referred to as the ‘debt snowball’.
A blended approach
I’m curious if a hybrid approach may best suit you:
- Firstly order the debts by the highest interest rate first (so you save the most interest)
- Then to give you the extra motivation you may need while establishing a new habit move to the top and start with either the:
- Smallest balance so you perceive progress sooner
- Most irritating debt so you can remove the irritation
The critical ingredient
Critically, to get out of debt you need to change the habits that got you there in the first place.
Otherwise, you may end up with no progress, or worse, going backwards, which could be very demotivating.
Don’t leave being debt-free to chance! Have a thorough plan of what is affordable and a process for sticking to your plan in the face of abundant temptation and easy credit.
How to Crush Your Debts – Upcoming webinar