Science just discovered the best way to pay off debt, use psychology on yourself.
It’s not fun being in debt. Given the average US credit card holder holds over $16K in debt (stats for 2016), the road back to solvency may seem impossible.
We do have some good news. Scientists have discovered a way to fool your brain back to financial safety. The Harward Business Review published an interesting report here which explains which payoff strategy works best.
The debt-snowball method is the simplistic debt reduction strategy. You examine all individual accounts you owe money against. You select the account you owe the least to and clear that debt first. Remembering to make minimum payments on other accounts to avoid charges of course! Following this, you work your way up the debt size list, clearing account by account. As you clear smaller debts, you free up debt repayment space for the larger debts.
The debt-avalanche method contrasts as you focus on the debts with the highest interest first. With this approach, you clear out the accounts that have the potential to hurt your pocket the most, regardless of the size of the debt. As with the debt snowball method, you avoid late charges by providing minimum payments on other accounts. Also, as you clear accounts, you free up income to tackle the other debts quicker.
The debt-consolidation method requires you to find a single source of credit which will cover most/all of your existing debts at an interest rate lower than you have been paying. With this approach, you use the balance gained from the single consolidated account, clear all other debts and focus your efforts on clearing a single debtor account.
Which method is best?
The math doesn’t lie, the debt-avalanche method will cost your less in interest so is the financially more efficient route than debt-snowball. Assuming your credit history is good enough to achieve a low-interest rate for the sum of all debts, debt consolidation can be more efficient still.
However, after scientists collected data from over 6000 people, those who focussed on clearing smaller accounts first (debt-snowball), achieved better results than debt-avalanche‘rs!
Turns out, with quick wins, you win both the battle and the war!
How will debt psychology influence me?
Although the debt-snowball and debt-consolidation methods are the most efficient over the long term, your first win may be difficult to achieve. At this point, you are paying at least minimum payments on all accounts, and your highest interest account may well have the highest balance. Your sense of progress may feel delayed, even more so with a single consolidated debt. Will you give up or slow down while the going gets tough?
Alternatively, if you focus your efforts on the smallest debt, clearing that will give you an early win. An early sense of progress and control. The scientific analysis indicates that momentum and sense of achievement is more critical than paying the least amount of interest.
How should I repay your debt?
If you have an iron will, are very focused on the long term or have a really high-interest debt, paying that off first or refinancing into a lower interest loan can make a lot of sense.
Unfortunately, if you lose momentum, this increases your likelihood of failure which would push out the time it will take to become debt free.
Whatever approach you select, take action!
Moving your financial position forward is the first step required to make your money work for you. If you think paying off smaller debts first will work, ignore the math and start moving forward. Your bank balance will ultimately thank you.
What do you think will work for you – have the scientists got it right this time? Have you used these tactics? How did it go?