As noted in our last post, Ryan was able to save up a bunch of money and repay more than the minimums on his student loans. This got us both thinking about loans and payment plans.
Earlier in the year Ryan had been avoiding paying one loan that was 0% interest because financially it made more sense to have the money in our accounts earning interest rather than paying it off quickly. This was one of the smaller loans, and it was completely knocked out this month.
At the beginning of this month Ryan’s ideas on loan repayment seemed to change – he had switched from a purely economical point of view to more of an emotional one, and was determined to kill the loan as quickly as possible even though it was small and zero interest.
This had always been my view, but I have been an avid Dave Ramsey fan and adhere to his idea of snowballing and paying off loans smallest to largest. Snowballing, and snowflaking are two ideas that involve collecting money in smaller amounts and paying off debt smallest to largest, regardless of interest rate, so you can build up attacking power and knock them out as quickly as possible.
With snowballs you start by paying the minimums on everything other than the smallest loan, and attack that with all you have. Then when it is gone you take the minimum from the dead payment and pile it onto the payment of the next smallest loan – attacking that one with everything you have. This continues until you pay off the final loan with a combination of all payments from previous loans.
Snowflaking is the idea that any money you planned on spending and didn’t, or that was not accounted for in your standard income for the month (like income from income streams) is put aside into a “snowflake” fund and used to build the snowball used in attacking your debt. This is a surefire way to increase the snowball’s power with little streams of flakes coming in throughout the month.
These methods do not take into account the financial logic of interest rates and paying off the most expensive loans first – they rely on emotion and the fact that you get excited as you start seeing the debt really disappear.
The other way to pay off loans is the mathematical (non-emotional) way. This method involves looking at which interest rates are the highest and paying those first, in attempt to have the higher interest rates apply to smaller and smaller principle amounts. The loan with the highest amount of interest accruing gets paid first – this way you save money by having less interest to pay in the long term.
Originally this was our plan and Ryan put money towards his highest charging student loans rather than paying off the smallest (0%) loan that we could (and eventually did) pay off in a lump sum. This method isn’t as emotionally satisfying, but does probably save you a couple hundred, maybe even thousand (depending on how big your loans and interest are) dollars.
I’ve always been an emotional debt killer – and Ryan is a new follower. He paid an extra payment on a loan and was “hooked” saying it felt great and he just wanted to pay more and more off. But we have also experienced the logical by the numbers path, and it works too.
What are your views? How are you paying off your debt?
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{ 6 comments… read them below or add one }
The real issue is self-discipline and how much you have. Dave Ramsey assumes that most people don't have it so goes the emotional route even though it costs money and takes longer to pay off the bills than steadily taking the economic approach.
We took the economic approach and paid off our bills a few years back. We also keep and use a credit card that has a nice cash back, and have it set to automatically be paid in full each month. Dave Ramsey discourages credit card use as he says it makes folks spend more and not pay them off. We don't find that … but keep a detailed record of ALL expenditures and find that cash disappears too quickly into "miscellaneous."
SO — if you are very certain you have the self-discipline to do it, go the economic way … if not, stick to the emotional approach, at least you'll feel good.
We have credit cards with cash back too, and always pay them off each month. I disagree with Dave on that particular issue and agree with you a lot more. We always make sure to keep detailed records – I agree, it's vital.
Paying back debt based on interest rates makes more financial sense, but the gain from that doesn't outweigh the emotional aspects of seeing payments disappear. We have pretty good self-discipline but I still like the emotional repayment better. Again – this is new for both of us, and the economic way works too.
Definitely an emotional driven debt payer, especially when you have more than one debt to pay off. It makes you feel like you accomplished something.
I am definitely an emotional debt reducer. The great thing too is that our lowest balance has the highest interest rate. The next lowest is the next highest etc. We are going to snowflake starting in January. Right now our extra money is paying for Christmas gifts (or stuff to make them). Once the holiday is over the snowflaking will go towards the lowest debt.
In the past year I've flip flopped on this. Currently I'm on the emotional side of things. It's nice to see the number dwindling so fast. A bigger reason for me thought was getting my spouse to agree. It was easier to argue for my car loan b/c it can be done in a matter of (good) months than the student loan that was more than a year.
We're emotional, as well. It didn't make sense to tackle our highest interest rate loan (the mortgage) before we hit lower-rate student loans. I'm of the opinion that all debt is debt, and should be paid off asap.
I really think it depends on your situation, though – we had a mortgage at 6.5%, a modest student loan at 5%, and a tiny ($500) student loan at 0%. It just didn't make sense to tackle our bigger debts and let the tiny student loan drag on. We paid off our loans in the first year of marriage, which opened up a lot of income to pay down the mortgage and funnel more money towards the retirement accounts.
Of course, if you toss in a 19% credit card into the mix the math changes completely. I think we would have ignored the 0% loan until that was paid off.