Posted on by t


Debate goes back and forth between financial experts about the best ways to pay off debt. In particular, how individuals, families, and businesses pay down credit card balances is of particular interest.

The basic premise of the argument is between whether paying off the largest debt first is ultimately more beneficial for the debtor, or if starting with the smaller debts first is the better option. The two discussion points are expounded upon below:

Option 1: Paying the larger debt first lowers the amount of interest paid, and therefore is more cost-effective

Let’s use a fictitious example of an individual consumer named Jim who has his spending under control, and has started paying off his debts. Jim has accumulated $6,000 in credit card debt, $1,000 on card A, $2,000 on card B, and $3,000 on card C. We’ll also assume the interest rates on these three cards are the same (although that wouldn’t have to be the case for this discussion to be viable…even with heavier rates on the larger cards, the ideas remain the same):

Proponents for Option 1 would use a mathematical approach, and clearly dictate that larger balances incur larger amounts of interest owed, and therefore to save money, one pays the largest balance first, and let the smaller balance incur the lesser interest.

Option 2: Paying the debts from smallest to largest encourages the debtor to continue paying off their debts

Dave Ramsey is one example of a proponent for Option 2. He posits that the hardest part of paying off debt is being consistent, and the hardest part of being consistent is not seeing the fruits of one’s labors. Although larger debts obviously incur more interest, an argument can be made that paying the larger amount does not in fact save money in the long term, because by paying the smaller debt off much quicker, that money that would have been spent paying interest can go towards paying off more debt.

 

We hope you enjoyed this blog post! For any accounting or bookkeeping questions, call us at (480) 467 3475 or visit bookkeepingvalleywide.com!

 

Posted on by t | Posted in Accounting