Snowball debt pay-down method melted?
A while back I told you about the snowball method for eliminating debt. It seems that some academics have melted it.
To use the snowball method, make a list of your debts from smallest to largest. Keep making the minimum payments on every bill and buy the necessities of life, but don’t rack up any more debt. Put any extra money toward paying off the debt with the smallest balance.
When you've paid off that debt, take aim at the next biggest balance. Pay both the minimum payment and the money that you had been paying on the first debt.
Proceed in this fashion until you've paid off every bill.
According to Scott Rick, a researcher at the University of Michigan's Ross School of Business in Ann Arbor, Mich., that version of the snowball method isn't always the best way to pay off debt. In fact, sometimes it can cost you money you might not have spent if you'd done things differently.
The reason, Rick says, is that it's better to pay off debt from issuers that charge higher interest rates first -- and that debt isn't always in the account with the smallest balance.
According to his article, published in the November 2011 edition of the Journal of Marketing Research, consumers should figure out which debt costs them the most and pay that off first. Then pay off the debt with the second-highest interest charges, and so on down the line.
Is Rick right? Sure.
From a mathematical point of view, he's spot on. But he misses one very important point: You can pay off the smallest account first or you can prioritize paying off the account with the highest interest rate. Either way, you're paying off the debt.
And that's good. Far too many people simply make the minimum payments on their cards -- credit users have an average of five credit cards, each with a balance of more than $1,000 -- and never make a plan to get out of debt or a budget that will keep them out of debt once they've obliterated that last "balance due."
The absolute best snowball method involves paying off the high-rate debt first. But, if you need the mental boost of wiping out those small debts first, go for it. Whatever debt-elimination method helps you make a plan and stick to it is the right method for you.