Saturday, August 22, 2015

"Smallest Balance First" Method: Eliminating Credit Card Debt

There is one chore that I cannot stand doing...Laundry...  Thankfully, I live in NY, and I use the drop-off service (I did the math, it turned out that doing it myself wasn't really creating much savings).  The thing that I hate the most about doing laundry is the fact that it never looks like any progress has been made.  On the other hand, I love doing the dishes because I immediately see something change.  I find that very motivating.  Why am I telling you about my housekeeping likes and dislikes in a personal finance article?  Simple.  We can learn a lot about ourselves financially, but looking at ourselves in non-financial situations.

Last week, we took a look at the "debt snowball" method of paying off credit card debt.  There is really no way to go wrong with that method, unless of course you run into motivation issues.  On one hand, paying off your credit card debt, and becoming debt free should be pretty motivating on its own, however; there are situations where the debt snowball can make you feel like you are attacking a never ending pile of laundry!

For example, perhaps you have created your list of credit cards, the balances, interest rates, and minimum payments, and you are looking and something like this.

  1. Retail Store Credit Card----$4500 (bal.)----19.99%---$75 (min. pmt)
  2. Airline Credit Card----------$3000 (bal.)----14.90%---$65 (min. pmt)
  3. Credit Union Card-----------$1200 (bal.)-----7.90%----$25 (min. pmt)
Notice, these bills were ordered from highest interest rate to lowest.  This the way you would look at it if you were planning to use the snowball method.  The idea is that the Retail Store Card listed above is costing you the most in interest every month.  It is the most expensive of the three debts.  So, you then take a look at your other bills, and find that after making all minimum payments, and all bills paid, you can put an extra $400 per month to eliminating the balances.  Next you identify that if you use the snowball method, you will put that $400 to the Retail Card, you start punching numbers into the calculator on your cell phone, and learn that it will take you almost a year to get rid of ONE credit card.  You feel immediately defeated, right?

Well, first off, you need to realize that it will take TIME to get out of debt. It is sort of like losing weight.  It is easy to put weight (debt) on, but takes a while to get rid of it.  That being said, you might consider trying a different method.

Try a Smallest Balance First method.  Put your extra $400 toward the Credit Union Card, while paying minimums on all of the others.  In roughly 3 months, you will have eliminated the balance on that card.  Then, you will start to apply the $425 you were applying the Credit Union Card to the card with the next smallest balance (the Airline Card).  You will continue on in this way, until you have eliminated all credit card debt.  

Using the above scenario, you will effectively eliminate the balances on two credit cards using the smallest balance first method, in the same amount of time it would have taken you to eliminate the balance on the Retail Store Credit Card using the snowball method.

While you are not eliminating your most expensive debt first,there is something to be said for the motivation that comes from seeing progress happen very quickly.  Take a good look at yourself.  If you are the kind of person that can't stand doing laundry because you feel like you never see any progress, perhaps the smallest balance first method is for you.

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