Comments on: How To Apply A Lump Sum Payment To Your Debt

By: Randy

Randy — Sun, 25 Jul 2010 11:07:26 +0000

Minda, you’re correct that 2% interest on $30k for 2 years is close to $1200, however, this ignores making payments on that $30k. If you use standard amortization to pay off that $30k over 2 years, the interest at 2% is only about $628.

The other factor being ignored is what Ramsey calls “gazelle” intensity. Once you pay off one debt, you get more excited and speed up the payments on the next. You end up making debt payment a goal and any “found” money goes to debt payment. If you only have one debt outstanding, you’re more likely to do this. If you have two, you’re more likely to splurge with found money.

By: Minda

Minda — Sun, 25 Jul 2010 01:43:22 +0000

@ Randy
2% interest on $30,000 for two years is close to $1200. I think that is significant enough for consideration. Although really any plan you can stick with is a good one.

By: Greg McFarlane

Greg McFarlane — Sun, 25 Jul 2010 01:28:09 +0000

Employing any strategy other than paying off the debts in descending order of interest rate is only going to lengthen the pain.
It’s this pseudo-mathematical rationalization gets people in debt trouble in the first place. Math is all that matters here: emotions are irrelevant. Save your emotions for your relationships with living beings. (Unless you can find a creditor who’s willing to accept feelings in lieu of dollars.) The idea isn’t to accomplish intermediate psychological goals: the idea is to pay off your debt as quickly as possible. But, people figure they can’t possibly pay their entire debt overnight, ergo it doesn’t really matter whether it takes, say, 7 years vs. 6 years and 3 months. But of course it makes a difference.
I’m sure Dave Ramsey’s a pleasant fellow, but the debt snowball is a bad idea regardless of how good it makes the practitioner feel. It makes no sense to get excited about eliminating small debts along the way, instead of regarding all your debt as one entity to take down as a whole, incrementally. It’s the equivalent of being excited that you now have ten bills in your wallet instead of four, even though the current bills are all singles and the previous ones were fives.

By: Trent

Trent — Sat, 24 Jul 2010 15:39:48 +0000

One important caveat to point #1: That “fact” you mention assumes a similar principal amount on the debt. I.e. if I have a $10,000 loan at 14% and a $10,000 loan at 7%, of course I should prioritize paying of the 14% loan. But if I have a $10 loan at 14% and a $10,000 loan at 7%, I’m going to pay a lot more interest on that 7% loan than I would on the 14% loan within a given time frame, just because of the principal. It’s an extreme example, but, given the reality that multiple debts are often quite varied in principal amount as well as interest rate, there is a point at which the actual numbers have to be assessed in order to develop the best strategy.

By: Glass Is Half

Glass Is Half — Sat, 24 Jul 2010 13:28:20 +0000

Wasn’t really on board with you until your point #3 … that actually makes a lot of sense as struggling to pay of $30K with no end in sight is definitely demotivating! If that same debt is split in multiple smaller increments it will assuredly feel more achievable.

By: Randy

Randy — Fri, 23 Jul 2010 22:05:20 +0000

In my brain, I agree with everything you said. In my heart, I disagree.

As Dave Ramsey says, personal finance is – personal. Paying off smaller debts is emotionally ASTOUNDING. It’s like losing the first 10 pounds on a diet. You actually ACCOMPLISH something.

If you pay off $70,000 of a $100,000 loan, you’re still left with the same payments on everything else. If you pay off smaller loans, you gain flexibility.

Also, your example shows 7% and 14% loans. Why wouldn’t you renegotiate the rates to something lower? Surf the debts to something better? I’d like to see a real life example where the difference is substantial. In most cases, people wouldn’t have that variance in interest rates on their debts. Saving 1% or 2% for a couple of years, won’t make that much difference.