High vs. low: Should I pay off the debt with the highest interest rate first or start with the one with the smallest balance?
An occasional extravagance vs. denial until it’s done: Can I stop and treat myself while paying off debt?
Let's start with the first question. The logical method is to first go after debt with the highest interest rate, because you will shell out less money. Yet let's look at the dilemma presented in "Belling the Cat."
A council of mice was convened to discuss a menacing cat. One mouse suggested a common-sense solution.
"Our chief danger consists in the sly and treacherous manner in which the enemy approaches us," the mouse says in the Harvard Classics' version. "Now, if we could receive some signal of her approach, we could easily escape from her."
Just like a cat, interest can sneak up on you, too. By putting higher-interest debt first, you're signaling that you understand its presence is dangerous to your financial health.
Let's say you owe $10,000 on a credit card with an 18.9-percent interest rate. If you make a minimum payment of 2 percent, it will take you more than 30 years to get rid of the debt. And the total interest paid will be $29,128.26, according to the minimum-payment calculator at bankrate.com.
In the Aesop fable, one mouse’s idea of putting a bell on the cat makes sense. But a plan is only as good as its execution.
An older mouse inquires, "But who is to bell the Cat?'"
Sometimes you can't use logic. When it comes to paying off debt, the mathematical solution may not be best.
Borrowers are more motivated to get out of debt when they concentrate first on the debt with the smallest balance, according to a 2016 study published in the Journal of Consumer Research.
In my own work with debtors, I find that when people are able to pay off a debt quickly, they become excited about their progress and speed up paying off the rest of their obligations. This in turn results in less interest paid overall, even factoring in the higher-interest debt.
Radio host Dave Ramsey is a leading advocate of the "debt snowball." I teach a similar system that I call the "debt dash." The idea is you start small, and before you know it, you're picking up momentum in your efforts to become debt-free.
“Personal finance is 80 percent behavior and only 20 percent head knowledge,” Ramsey writes in his book “The Total Money Makeover.”
With the debt dash, you list all your debts starting with the one with the lowest balance. Take any extra money you can find in your budget and apply it to that first one while making the minimum payments on all other debts. Once you've knocked off the top debt, take all that money and now go after the next one on your list, and so on. If two debts are about the same amount, the one with the higher interest rate gets priority treatment. Tax debt jumps to the top.
Make sure that your extra payments are applied to the principal and are not counted as an extra monthly payment.
The Aesop fable “The Tortoise and the Hare” addresses the question of whether you should treat yourself while getting out of debt. It’s a lesson in plodding over pleasure.
In this story, the hare speeds ahead but then stops to treat himself to a nap. He's overconfident. I think of the hare when folks proudly tell me they saved up for a vacation or they're continuing to eat out while still deep in debt. They shouldn't be stopping along the road to debt freedom.
Don't take a break from paying off debt to treat yourself. In fact, I want you to suffer. Because it's in your suffering that you learn a lesson.
Debt hurts. It can be debilitating. During the payoff process, I want you to feel the pain of eliminating luxuries so that you don’t get back into debt again. If you’re pausing to treat yourself, you’re boasting like the hare before you’ve achieved victory. The hare lost even though he’d been ahead.
If you’re truly committed to paying off debt, be the tortoise. He doesn’t stop, and his steady pace wins the race.