Don’t Feed the Alligators

A Personal Finance Blog from a Small-Scale Landlord’s Perspective

Now that you have Stopped Contributing to the Problem, Reduced the Cost of Debt, and Freed up Some Extra money, all as outlined in Part I, it’s time to look at the best way to attack the debt itself.

There are a few schools of thought on this. No matter which way you go, you will still need to make a list of all of your outstanding debts. Each item listing should have the outstanding balance, minimum monthly payment due, and current interest rate charged. Separately write down how much extra you can pay monthly towards debt elimination from the extra money that you freed up in Step 3 of Part I. Here’s an example:

Debt Owe Minimum Payment Interest Rate
Mortgage $250,000 $1,539 6.25%
Car Loan $15,000 $445 9.0%
Credit Card 1 $2,500 $100 13.0%
Credit Card 2 $14,400 $576 19.0%
Student Loan $25,000 $271 5.5%

Extra money to put towards debt reduction: $350/month

Option 1: Most Mathematically Advantageous

This method will see to it that you pay the least amount of interest possible. Reorder your list in order of highest interest rate to lowest:

Debt Owe Minimum Payment Interest Rate
Credit Card 2 $14,400 $576 19.0%
Credit Card 1 $2,500 $100 13.0%
Car Loan $15,000 $445 9.0%
Mortgage $250,000 $1,539 6.25%
Student Loan $25,000 $271 5.5%

Now add your $350 to the first payment on the list. In this case it is Credit Card 2. Now on a monthly basis you will be paying $926 to this debt while continuing to pay ONLY the minimum payments due on the other debts. When Credit Card 2 is paid off, add $976 ($576 + $350) to the payment for Credit Card 1, for a total of $1,076. When that is paid off, add $1,076 ($576 + $350 + $100) to your Car Loan for a total of $1,521. Continue “snowballing*” your debt reduction until all debts are paid.

Keep in mind that your credit card minimum monthly payments are a function of your balance and will therefore go down as the balance goes down. Resist the urge to reduce your payment to them and continue to pay the CURRENT monthly payment.

This method will result in the least amount of interest paid.

Option 2: Most Psychologically Rewarding

While Option 1 may save you the most money, it is clear that if Personal Finance were all about math, then few of us would actually have the problems we do now. Therefore, another approach that may help you stick more closely to your plan is as follows: Reorder your list again, but this time in order of the lowest balance to the highest:

Debt Owe Minimum Payment Interest Rate
Credit Card 1 $2,500 $100 13.0%
Credit Card 2 $14,400 $576 19.0%
Car Loan $15,000 $445 9.0%
Student Loan $25,000 $271 5.5%
Mortgage $250,000 $1,539 6.25%

As in Option 1, take the $350/month that you have pledged toward your debt reduction and apply it to the first item on the list. When the first debt is paid off, apply the minimum payment on that debt, plus the $350/month extra toward the 2nd item on the list. Continue in this way until all debts are paid.

The reason that this method is more rewarding is that it takes only 5.5 months to pay off the first debt using this method, whereas it will take 15.5 months to pay off the first debt in Option 1. 15 months is a long time to stay committed to something without seeing the progress of crossing one of your debts off the list. So by attacking the lowest balance debt first, you get rewarded by crossing debt 1 off your list in just 5.5 months, and then debt 2 follows just 11 months later.

Option 3: A Hybrid Approach

A third approach to this problem takes a mix of the above two methods. For this method, divide each balance by the minimum balance due monthly. Now order your list from lowest to highest:

Debt Owe Minimum Payment Owe/Payment Ratio
Credit Card 1 $2,500 $100 25
Credit Card 2 $14,400 $576 25
Car Loan $15,000 $445 34
Student Loan $25,000 $271 92
Mortgage $250,000 $1,539 162

In this example, the order is the same as Option 2, but depending on balances and minimum monthly payments this may not be the case. The bottom line is that it may turn out that a higher balance debt may have a non-proportionally higher monthly payment that actually means you would pay that off sooner than a lower balance debt when making just the minimum monthly payment. Keep in mind that the number of payments to pay off the debt does not take into account the interest rate.

As with the other methods above, you take the first debt, add your $350 extra per month to it until paid off. Then lather, rinse, and repeat with the other debts.

What method do you think is best for you? Do you have a method that I didn’t mention? Let’s hear about it in the Comments section.

In Part III of this discussion, I will discuss some tips, caveats, and warnings!

See also: Getting Out of Debt, Part I and Part III

* I’m not sure who first coined the term “Debt Snowball.” It may have been Dave Ramsey, who teaches Option 2 above. I would give credit where credit is due if I knew who originated the term.

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4 Responses to “Getting Out of Debt, Part II”

  1. Michelle LoDico Says:

    I like that Hybrid approach! I have never seem something like that before. (not that I look very hard, since my debt just scares me!) But I will be using it from now on. I have one card with a low balance but no interest, someone told me i should pay it off first because then it will be gone, but I see that my freed up money is better spent elsewhere since I am not accruing any interest on it, whereas my other card has a much higher balance but it charges me 14% interest! Keep the ideas coming buddy! =)

  2. MITBeta Says:


    Can you transfer any of the high balance card to a low or no balance one? You will likely have to pay a balance transfer fee, but it may be money well spent because it saves interest over time. Be careful to be sure that you know when the 0% interest deal runs out as well.

  3. Michelle LoDico Says:

    That is actually how I got the 0% interest one in the first place. I got an offer in the mail for 0% interest on all transfers for the life of the transfer, but it did not tell me until after I applied for it that it would only allow me to transfer $2000. So I got stuck with the two cards. So I closed the zero interest one so I wouldnt be tempted to use it (the percentage on purcahses was 24%!!!) But I wont be fallin for anymore transfer offers that seem too good to be true as they usually are. I may be transfering all or some of my balance onto hubbys card when he leaves as he has a very low rate and will not be needing it! Thanks for the suggestion!

  4. MITBeta Says:

    @ Michelle:

    A couple of comments:

    1. Sometimes it’s worth transferring some of the balance to a lower interest even if you can’t transfer the whole amount.

    2. If you get a new card from a bank with which you already do business, you can consolidate lines of credit. For example, I have a Chase Card, Chase Platinum Card, and Chase Freedom Card. The Chase Card used to have something like a $10,000 limit. I got the Platinum Card and it had a $12,000 limit. I called Chase and had them “move” my credit from the “regular” card to the Platinum Card so that I could take better advantage of a very low rate. My Freedom card has a $35,000 limit. This is the card I use for rewards. When my Platinum balance is paid off, I may “move” that credit to my Freedom card for a total limit of $57,000. Then I can go buy a car. Just kidding, of course. I would only do that for the rewards and if I had the cash available to pay the balance.