According to a 2016 study by NerdWallet, households with credit card debt are working themselves out of an average $16,061 hole. With respect to ridding one’s self of the debt chains and getting out of that hole, one school of thought is that credit cards with higher interest rates should be paid off first while the other school of thought suggests paying off those with the lowest balances first – sometimes referred to as the snowball method – is the way to go.
Research Supports the Snowball Method
From a purely financial perspective, the former is the better approach. However, there is value in the latter approach as there is a psychological lift – a real sense of progress – from paying off one card and then committing the money that was being paid on the first to the next card in line, continuing this progression until the last card is paid off. This was the approach the wife and I employed when eliminating our credit card debt and it worked well for us.
I discussed the method in a blog post last year and earlier in RENDEZVOUS WITH RETIREMENT: A Guide to Getting Fiscally Fit.
After conducting a series of experiments in which participants simulated paying back virtual ‘debts,’ Harvard researchers agreed with me and concluded the factor that made the most significant impact on how hard participants worked wasn’t the amount they were paying back or how much was left in the account afterward, it was the percentage of the balance they ended up eliminating. (Actually, I’m pretty certain they were’t giving me any thought when they conducted the research.)
Celebrate Being Debt Free With Some Snowball Cookies
“Focusing on paying down the account with the smallest balance tends to have the most powerful effect on people’s sense of progress — and therefore their motivation to continue paying down their debts,” noted Remi Trudel, one of the Harvard Business Review researchers.
While perhaps counterintuitive, my experience — and research — suggests the snowball method works well. However, whichever method you use, the key is to stop using the credit cards and stay committed to reducing the balances to zero while you start working your savings and investment plan.