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Are You Paying Down Debt the Wrong Way?


The recent market machinations are the latest indicators that the economic outlook is anything but rosy. For consumers, it’s not a bad time to reassess your financial picture and make a new commitment to saving and paying down debt — the right way.

A study in a forthcoming Journal of Marketing Research found that consumers often take what can be an expensive approach to paying down debt: They wipe out small balances first rather than focusing on the balance with the highest interest rate. “Our research finds that people really like closing accounts,” says study co-author Cynthia Cryder, an assistant professor of marketing at Washington University in St. Louis, Mo.

In fact, in a series of experiments, none of the participants consistently targeted high-interest debt for early pay-down. But that’s the smarter – and often more cost-effective – thing to do, says certified financial planner Lynn Ballou, a managing partner at Ballou Plum Wealth Advisors in Lafayette, Calif. Ideally, consumers should make the minimum monthly payment on every account, and put any extra toward the debt with the highest interest rate, she says. That can save you hundreds of dollars in interest over the life of the loan, and so help eliminate debts faster.

Study authors suspect that consumers take the other approach because it’s psychologically satisfying to see the number of cards with balances drop, even if your overall debt doesn’t change much in the process. “It’s the difference between what’s mathematically correct and what’s psychologically helpful,” says Ballou. And, she adds, that’s not necessarily terrible: “If that’s what it’s going to take to get you busy, then it’s a good thing.”

There is some wiggle room, too, to take the small-balances-first approach, if they truly are minor debts you can knock out in a month or two. Use our calculators to figure out how much interest you’ll pay in each scenario, and whether you should consolidate any of those balances under a lower rate.

A second mistake people often make when paying off debts is not figuring out how to avoid falling back in. “This whole paying down debt has to start with the notion of, what am I bringing home and what do I need to pay my bills now?” Ballou says. Otherwise, you are likely to keep overspending. After paying monthly bills, put a third of your disposable income into savings. ‘Then if some unexpected expense comes along, you’re more capable of dealing with it,” she says. Use the rest to tackle those debts.


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    • No. Those debts are already dheriacgsd. The bankruptcy will stay on your record for 10 years. However, you can start now improving your credit score.You can, and probably should, apply for a credit card. You won’t be able to get a very high limit but it doesn’t really matter because you aren’t going to charge a bunch of stuff on it. Make sure you get one that does not charge an annual fee. You’ll probably have a fairly high interest rate on it but the plan is to NEVER ever pay interest. Use the card regularly. Pay the bill when it comes. Do not ever be late on a payment and pay it completely off every month. Only use it for things that you would normally buy with cash anyway. I use mine for food because I’m going to buy food anyway so I’m not buying some stupid stuff that I don’t need. I pay the bill every month.After a while, by making regular payments every month, your credit score will start going up. It takes a while but it really does work.And don’t even think about splurging and buying those cute shoes just because the card is in your pocket. Under this game plan, you can’t charge anything you don’t have the cash to pay for.

    • If all you have is student loans and a gtgomare you’re doing very well! Don’t worry so much about paying off the gtgomare. Since you get tax money back from the interest you pay on that it is somewhat beneficial to have a gtgomare. Devote as much as you resonably can to paying down your student loans, but don’t make that your sole focus. Continue to make contributions to your retirement account as well as building up easy-access savings for if you have an emergency. If it were a case of you not being able to make your bills because you are contributing too much to savings and retirement I’d say reduce the retirement savings b/c you don’t want to live your life with that debt hanging over your head and when it’s paid off you will have more to contribute to retirement. However, always try to put a little bit (even 1% of your pay) into an account you can have access to when an emergency comes up. Many people make the mistake of not having savings and putting all their money towards paying off debt and when an emergency comes up they have to return to using credit and they are back at square one.References : I’m a 20-something in debt.

    • This article admitted that people take the “smallest first” approach because it is psychologically satisfying. And looking only at the math completely ignores the psychology. Bad idea, because if we all looked at the math, we would not have high-interest debts in the first place! This is about behavior modification. It’s like dieting: if you see results, you’re motivated to keep at it, maybe even pick up the pace. But if you do not, you give up. Paying off small debts first may not be mathematically correct, but for the way we as humans are wired, makes perfect sense.

    • why should the taxpayers pay for your debt,Don’t we live in a world. Wear it said its my credit i want it nowwwwwwwwwwww. So pay up.

    • Enroll in Dave Ramsey’s 13-week money management course, Financial Peace University. It’s better advice for paying down debt and changing your financial future permanently.

About Pay Dirt

  • Pay Dirt examines the millions of consumer decisions Americans make every day: What to buy, how much to pay, whether to rave or complain. Lead written by Quentin Fottrell, the blog examines these interactions, providing readers with news, insight and tips on shopping, spending, customer service, and companies that do right – and wrong – by their customers. Send items, questions and comments to quentin.fottrell@dowjones.com or tweet @SMPayDirt.