This is an update on a post I wrote a few months ago:
In order to make my goal of being consumer debt free by age 45 I have to pay off two major debts. When paying off debt there are two common avenues recommended: Paying Highest Interest First and the Debt Snowball.
Pay Highest Interest Rates First
In the first scenario, you take all of your debts and no matter the debt you make minimum payments on all of your debts and throw all of your extra money at the debt that has the highest interest rate. So if you have three credit cards and they have balances at $6,000 (15% interest), $2000 (12% interest), and $8,000 (20% interest) you would pay off the $8000 debt first and then when that is done move onto the next one and so forth.
Mathematically, this first scenario presumably saves you the most money. However, because the debts are so high and you may not be getting a lot of traction right away, human beings don’t stick with the plan of paying off those high interest rate debts, and see enough progress being made toward paying off the debt. Without that visible progress they give up before they make any headway. Subsequently, you wind up essentially where you started from: lots of credit card debt, frustrated with yourself in your inability to pay off debt, and little financial flexibility.
Debt snowballing is a method that has been popularized by Dave Ramsey. Dave argues that you should list all of your debts smallest to largest no matter the interest rate. Then you make minimum payments on all those debts and throw any extra money you have at the smallest debts. Then when you pay that off you take that payment and throw it at the next largest debt and so forth until you pay off all of your debt. The idea is that by paying off those small debts first you get quick wins, which gets you excited about making progress on your debt, increases your enthusiasm, and is more than likely, according to Dave Ramsey, to lead you to pay off debt faster and quicker than you would if you went paying off debt with the highest interest rate. Studies indicate that Mr. Ramsey’s approach is the best.
While I love Dave’s method it, in some respects, becomes a bit of a different for my situation and people who have specific debts (e.g. school loans) that are not hundreds, but thousands of dollars. The whole point of the snowball method is to get quick wins to create the mindset that you can pay off debt, you can accomplish this goal, which means you will stick with it. Well, I have two very large debts with pretty low interest rates (2.3% and 4.5% respectively). How do I keep myself motivated when I have these large methods and I don’t see a whole lot of progress? In other words, the balance doesn’t go down fast enough.
In my case and it may work for others as well, I think we should introduce the method of debt chunking. Cecelia over at The Single Dollar wrote a great post about how she has trouble sticking to her plan and isn’t good at the slow and steady. She is more of a boom or bust person. I can relate quite a bit. I believe I am a boom or bust person. I am pretty good at saving, but when it comes to paying off debt if I don’t see that debt go down exponentially fast then my will power to stick with the plan abates. I fully admit I am impatient and want this gone like tomorrow. If I don’t see progress I try to come up with some other hair brained scheme to come up with another way to pay off that debt. But instead inertia sets in and I end up saving that money or spending it on other items. Psychologically, it is difficult for me to just plug away month and after month and only watch the balance go down by a couple hundred dollars here and there. Yes, I know slow and steady wins the race, but my impatiences gets the best of me. So I have to change my thinking on paying down the debt and sticking to the plan. Here is where the debt chunking can come in and help me accomplish this over all goal.
I define debt chunking as having large debts (you can decide what qualifies as huge) where you pay it off in large chunks instead of the debt snowball method of throwing every extra dime at every single month. For me large debts appropriate for this debt payoff method would be something I couldn’t realistically pay off in six months or so.
In order to get the psychology of the debt snowball’s quick wins, but see larger progress with these huge debts the trick, for me, is to divide them into smaller chunks. For example, my smallest debt is just over $28000. I could divide this debt into ten chunks of $2800 or seven chunks of $4000 or whatever it is. I like round numbers so by paying the debt to get down to round numbers, for me, makes it seem like it goes faster. What I plan on doing is: 1) continuing to make minimum payments on my debt; 2) divide the debt into larger chunks (e.g. chunks of $3000 or whatever); 3) whatever money I have extra that money I put into a savings account; 4) once I have saved enough money for that chunk then I automatically transfer the money to the debt. Then I move to the next chunk. I think I can do this because I teach extra courses and do some side hustles at school to earn a little extra money. I am pretty good at saving small chunks of money in short periods of time. And because I like seeing it grow I am more apt to put that money aside in a savings account.
In this scenario I get to save money (which I have found I am pretty good at) and at the same time get small psychological wins as I pay off this debt. These small psychological wins will keep me more motivated to pay off these larger debts.
I am still working out the bugs on this, but I think it can be a really effective method when dealing with larger chunks of money. You can still get the psychological benefits of the debt snowball and pay down your debt faster. Now the key is sticking to the plan (which is the ultimate key for any debt payoff) and using those chunks to pay off debt instead of other things, but I think it can work.
What do you all think? Are you a debt chunker? Can it work for you?