We’ve talked before about paying off your debt with the snowball method or if paying off in order of highest interest works better. Now, the Kellogg School of Management has done an actual study to determine which method is more effective.
Researchers obtained the data of how 6,000 people paid off their credit card debt from a debt settlement company. After examining how each of the 6,000 people became debt free, they determined that those who went against the more popular high-interest method and used the snowball strategy were more likely to be debt free.
Their main conclusion was that “Closing debt accounts – Independent of the dollar balances of the closed accounts – predicted successful debt elimination at any point in the debt settlement program.”
The obvious question is why would people be more likely to become debt free at the same time they’re paying more in interest costs to service their loans? The answer is in the victories and confidence that comes from closing off an entire debt. Consider an example. Two people with $20,000 in debt. One has a single loan with a 3% interest rate. The second has a $2,000 debt, an $8,000 one, and a $10,000 one. Even if the interest rates are higher, this person targets that first $2,000 with everything they have. Both people pay back $2,000 at the same time. The first person now has a balance of $18,000. It’s a good chunk, but they’ve still got a LONG way to go. The second person however completely wipes out that $2,000 debt. Now when person #2 looks at their situation all they see is an $8,000 debt and a $10,000 one. Sure the $8,000 loan will take longer to pay off, but in a way they’re already one-third of the way there. This is the mind-set that people end up with when using the snowball method – slightly higher interest charges can’t hold a candle to the excitement of knocking these debts off. If you’re currently working towards paying off your debts, consider trying the snowball method. Pick your smallest debt and throw everything you can at it. See how it feels in a month or two when it’s completely gone and you never have to think about it again. If you’re worried about the extra interest, at least take a moment and calculate what it will actually be – it’s often a much, much smaller amount than you assume it will be.