Quote of the day

I’ve not thought too much about Dave Ramsey for some time, not since before I adopted this format and was writing a monthly article. In one article I discussed his Debt Snowball, and quote him as saying “Myth: I should pay off the debt with the highest interest rate first to get out of debt quickly. Truth: You should pay off the smallest debt first to create the greatest momentum in your debt snowball.” I understand when authors are responding to a question from a reader often don’t have the time or space to offer as detailed a response as they might like. This statement, however, was on his site as a rule to follow, and he even added, “The math seems to lean more toward paying the highest interest debts first, but what I have learned is that personal finance is 20% head knowledge and 80% behavior.”

A few weeks back Adam Baker of the site Man vs Debt showed me another spin on the paying down of debt in his “Debt Tsunami: The Ultimate Method For Paying Off Debt.” No problem with this, Adam acknowledges the differences in payoff methods, and suggests that one should lower their stress while lowering their debt. (I like that idea, and his approach.)

Then, I read Money Smarts’ Is Dave Ramsey a “Financial Expert” and this prompted me to start polishing a spreadsheet and newer article I’d been working on to take another look at the Snowball. To clarify, if you’ve not heard of Debt Snowball yet it simply means that you line up all your debt by balance. You then make the minimum payments on every debt, except you pay any extra money budgeted to paying off the smallest current balance. I’ve always claimed that paying in order of rate is the right way to handle this.

Late last week I read another article, Fiscal Geek’s The Debt Snowball Saved my Marriage: Spreadsheet Tell-all and found via his site, a spreadsheet The Debt Reduction Calculator, which amazingly, offers a pulldown tab which allows you to choose your method of payment.

First, Dave’s Debt Snowball:

Then the Debt Avalanche (paying highest rate first):

Wow, the difference is \$4381.62, quite a difference. Now, to explain, the most dramatic difference comes from the wide spread from high rate to low, as well as the balance on the high rate card. Would you really feel better paying those smaller balances so quickly once you learned that those good feelings came at such a high cost? I didn’t think so. And my experience shows that your lowest rate cards may very well be the cards with the lowest credit lines as well. So you might have four cards each owing \$2000 at 10%, but one card with a \$10,000 balance at 24%.

Tell me, does this put an end to the Snowball debate?

Joe

• Four Pillars July 6, 2009, 8:51 am

Thanks for the link. Good analysis!

• Augustine July 6, 2009, 10:24 am

What debate? I guess that it can only be a debate to someone who’s racked up \$25G at 25% in debt. IOW, someone who thought “tomorrow be damned, I want this or that now because I deserve it.” Well, deserve it one does.

• JOE July 6, 2009, 10:56 am

As you’ve observed, I’m a numbers guy. The debate regarding Dave Ramsey’s ‘Debt Snowball’ has been that the numbers show paying High Rate debt first is better than Dave’s method of Low Balance. Of course, I set the example shown to favor my position, to contradict Ramsey’s stance of “do it my way,” as if his is the only method. Is \$25K of credit card debt so out of line? I don’t think so. Above average, but not unheard of.

• Augustine July 6, 2009, 12:43 pm

\$25G is still out of line for any mature adult… Maybe such an overgrown adolescent needs to “feel good” rather than to feel responsible.

• JOE July 6, 2009, 1:13 pm

Agreed. I’m not passing judgment (on these debtors), this train of thought assumes they are out there, and hoping to get them on track with their finances. I’m also hoping that readers who see these crazy numbers will take some advice and not get into this kind of mess.

• Dan July 6, 2009, 1:44 pm

If you accept Dave Ramsey’s belief about behavior being the #1 factor and math being #2 then the debate is still ongoing.

If someone can get motivated by paying of a small balance credit card and cutting it up and then continue on with debt payoff, good for them.

That same someone, might get discouraged after only paying off 2000 dollars on a 10000 card and still owe 8000 and think its taking too long and quit.
In this case, this person might end up paying a lot more in interest overall then with Dave Ramsey’s method.

Everyone gets their motivation differently. I lean towards the Math approach, but if you pick a different method, as long as the debt is being retired and your motivated, good for you.

• JOE July 6, 2009, 1:59 pm

Dan, my problem is not with behavior, let me acknowledge your point, and agree especially with your words,”Everyone gets their motivation differently.” My issue is that Dave dismisses the best mathematical way to do it, calling “I should pay off the debt with the highest interest rate first to get out of debt quickly” a myth. He does his readers a disservice to use that as an example and steer people to his method. I view him as arrogant and his advice, flawed. At the very least, I offer the cost of doing it either way, through the sheet I linked to. If the difference is a few hundred dollars, and you can get rid of the nagging 3-4 card statements, that may be your choice, what’s right for you. But another mix, as in my example, will cost you dearly. He doesn’t mention that.

• Dan July 6, 2009, 2:25 pm

JOE,

I occasionally listen to Dave Ramsey if I’m in the car and it’s on. Many of the people who call in tend to be illiterate when it comes to money. I agree he appears arrogant when it comes to him expressing his opinion as fact. For his audience it seems like he tries to keep things as simple as possible. For those people that seems to be effective.

BTW, I enjoy your site. You have a lot of good info and insights. I ran across it a year and a half ago or so when I was looking at the money merge account with UFF. Talk about a waste of money!

• Augustine July 7, 2009, 12:55 pm

I wonder if the spreadsheet could be concocted in such a way to achieve both: getting rid of a lower balance early while at the same time minimizing the interest paid over the life of the loans. Is it possible at all?

TIA

• JOE July 7, 2009, 1:56 pm

Yes, if the lower balance cards also carry the lower rate, then both methods are the same.
On the other hand, if you told me your highest rate was 12%, but you lowest was 10%, that difference may not add up to too much, or at least not the \$4,000 in my example. Keep in mind, I used numbers that favored my position. But I also acknowledge that there are situations where it may make little difference. Dave is firmly ground in his own view, and no other.

• Mr. Charles' debt guide July 7, 2009, 11:14 pm

nice analysis, great point of views…the graphs, everything is good

• brainy July 8, 2009, 10:45 am

Nice analysis! You’re right, though, the HUGE disparity between your highest rate and your lowest rate are what made the difference.

While I was paying down debt, I researched both methods and the difference was a mere \$200 or so over the span of two or three years. It seemed a wash — though my rates were all in the vicinity of 9-15% or so…

Oh, and that calculator is the best I’ve ever found… Thanks!

• JOE July 8, 2009, 12:16 pm

No doubt, but I am a numbers guy, scientific method. It only takes one example of this kind to prove that Dave’s “never” is simply wrong. You are right, if the rip-off rate were only 14.9%, say, the difference drops to less than \$400. And I’ll say “if you feel better dropping the number of bills you get, that’s ok by me, just understand, it will cost you \$400 extra to do that.”
What’s so wrong with that?
BTW – My HELOC rate is 2.5%, and I actually have cards I pay in full whose rate would be 24%, so is that high/low spread so unreasonable?

• Elle August 5, 2009, 4:48 pm

What if Dave Ramsey produced a study showing that, on average, his approach is more effective at reducing personal debt for the masses than your approach? Is he still “wrong” in your eyes? Is his approach still lacking in both numbers and science?

• JOE August 5, 2009, 4:58 pm

(Good to see you here, Elle!) Let me be clear, Dave’s method may very well be right for 90% of the people. My issue is with his position of dismissing the high rate payment method as myth or incorrect. I continue to say things like “do the math and determine what each method will cost you,” if the difference is minimal, by all means use Dave’s method. But my example while contrived is likely not so uncommon. I found that banks that gave me the best rates also gave the lowest credit limits, so I had a dozen cards at 12% with low lines, but one nasty high balance at 20%. I am open to the idea that feelings can and do come into play, often talking about a portfolio that lets you sleep, it’s Dave that appears to be completely closed minded, dismissing the financially superior method.

• Elle August 11, 2009, 9:32 am

Hi Joe. I would say we need to consider Mr. Ramsey’s audience vs. your audience. Ramsey is sort of a populist, appealing perhaps especially to those with a certain religious bent and maybe not all that much post high school education. Some 73% of the age-eligible population lack a bachelor’s degree. Ramsey has to do what he can with an arguably not-so-sharp, very likely overworked, population in very limited space. Assuming studies do show that the average consumer will pay his or her debt off most quickly by prioritizing by size of balance (rather than interest rate), I would not call him close-minded. I certainly think it is worthwhile to point out, as you have, that he is mistaken as a matter of financial numbers. But he is not necessarily mistaken as a matter of “the best solution” for getting the masses to pay down debt, using as justification those other numbers towards which I feel it is unscientific(!) of you to pay short shrift ;-). I will not knock Mr. Ramsey or Ms. Suze Orman or anyone, per se, who ultimately is getting people to pay down debt, especially when so many sharks, and even our government on certain fronts, is urging people to take on more debt.

As far as the difference in the two approaches possibly being miniscule, I would say that your approach promotes more careful thinking about budgeting in general. Watching a dollar here and a dollar there does add up. Besides, even if we are only talking on the order of \$20 saved over a year using your method, \$20 is still a nice lunch out in many towns.

Hats off to both Dave and you for helping people master their own destiny. 🙂

• JOE August 11, 2009, 12:40 pm

I thought my conceding to the 90% (above comment) showed my consideration for his audience, no?
I am trying to be open to the ‘feeling’ nature of financial matters. I don’t know how we can get any data to prove either side of this issue. Is there really a way to find those who are part of Dave’s demographic but chose the high interest method? I can cite numbers all day long, but of course numbers don’t equal success, I know that.

So really, what I am left with is to suggest when I am confronted with the debt snowball is to offer the spreadsheet on line and tell a reader that with their numbers entered they can see the difference in methods. If they are a “squeeze out the last nickel” guy, they may jump on the high rate method. If the idea of knocking off cards regardless of rate/balance, by all means use the snowball. Better?

• Elle August 12, 2009, 6:52 am

In my opinion, and speaking as a retired engineer and so fellow problem solver, characterizing Ramsey’s approach as being about the “‘feeling’ nature of financial matters” is unfair. I think it should be conceded that Ramsey’s debt reduction approach may be as much about numbers and science as your approach. I do not expect you to take psychology (which I think has plenty of science) into account with your financial planning solutions. But when others do, I won’t dismiss it as non-science and non-numbers.

Two cents (maybe from someone who one way or another has worked a little more with the masses? I would bet money that the overwhelming majority of those reading and participating here are four-year college educated, and so you are writing for a much more literate audience than the nation at large.)

• JOE August 12, 2009, 8:23 am

Elle, your visits and comments will always be appreciated. On this topic, I hope we can simply agree to disagree.

• djao April 7, 2010, 1:17 pm

I’m a mathematician, and I find no problem with what Dave Ramsey is saying, even though Joe is also right. I believe Dave Ramsey makes it sufficiently clear that his method is based on psychology, not mathematics. At no point does Dave Ramsey claim that his snowball method is mathematically optimal. In fact, Dave states clearly that “The math seems to lean more toward paying the highest interest debts first”. The only mistake he makes is that the math actually leans outright toward paying the highest interest debts first, not just “seems to lean,” but this mistake is not major.

Another fact that I find interesting is that that there is (believe it or not) a valid mathematical justification for paying off debts by size of balance. Most credit cards charge a sizable late fee if your payment is even one day late, and for most people, there is a nonzero probability that they will accidentally forget to pay any given bill on time for whatever reason. By paying off your smallest balances first, you reduce the total number of bills that you have to pay over the lifetime of the debt. Even though these fewer bills represent a larger total amount of money, the trade-off can be worth it if you are forgetful and prone to missing payment deadlines. The exact strategy that works best depends on your situation. If, as in Joe’s example, the difference is \$4000, then you’re not likely to save that much in late fees or interest on the late fees, but for a difference of \$400 or so, it might be worth it.

• DJ December 16, 2010, 11:20 am

I remember Dave saying in his video (and I paraphrase) that if we were doing math to begin with, we wouldn’t be having the massive debt issues to deal with. He acknowledges that it’s mathmatically better to pay off the debts with higher interest rates, but that getting rid of the smaller ones builds momentum.

• JOE December 16, 2010, 11:28 am

I had cited a quote from his web site where he dismisses the “high rate first” approach. My only point is that there’s a cost to his method. If it’s small, no issue, but if there’s a lot of money involved, one should be aware and not blindly follow the snowball.

• Dave Ramsey January 31, 2011, 5:39 am

God bless Dave Ramsey. Dave has done more to improve the lives of my family and countless other families than the combined efforts of Senators McCain and Obama.

• JOE January 31, 2011, 8:24 am

I’m genuinely happy for you. If Dave is the teacher who helped you to a better life, then indeed, God bless….

• Andrew March 31, 2011, 1:38 pm

Just came across this article… very informative and the comments have been quite insightful. Thanks for writing!

As an educated numbers guy who years ago always struggled with paying off debts, I can relate to BOTH sides of this argument. I continued year after year of trying to pay down debt (highest interest rate first), in nearly the same situation that is outlined in the example: One large debt with high interest, a couple of moderate debts with moderate interest and several small debts with low interest.

I kept trying to pay down that large debt and never seemed to make progress. And having the smaller debts just getting by with minimum payments creates an unnecessary amount of stress. Those bills were always hanging around and still needed a lot of attention.

About 4 years ago, I first learned about Dave Ramsey and the pay low balance snowball method. What he talks about, mainly staying out of debt, makes total sense. And it is common sense. Sure it isn’t the “mathmatical” way to do it, and he always says that if we were doing things on pure mathematics, we wouldn’t be going into debt in the first place. Mathematics says, if you don’t have the money to pay for something, you can’t buy it. Because if you’re borrowing money to buy it, you are paying MORE for it that it is worth because you will be charged interest which increases your cost of what you bought.

I tried out paying the smaller balances first, and low and behold, those quick wins by paying off many of the smaller debts, created a ton of motivation to get everything paid off and become debt free. The stress relief of having fewer bills bombarding me every month was enormous.

The mathematicians, accountants and financial world LOVES to bash Dave Ramsey, calling him all kinds of unfair things. But if you truly think about it, his advice is pure common sense. Just stay out of debt. And if you’re in debt, this method will provide you with the most successful way to get out of debt. I truly believe now that it wasn’t the math that was the problem, it was me. I needed those little victories of paying off the small debts to see the finish line.

Yes, there is a cost to paying the lowest balance first. He concedes that every day. But the chances of getting the out of debt victory are higher. As a mathematician, would you totally ignore (for example) an 75% success rate over a 25% success rate? As someone who has been on both sides of the fence, you cannot ignore the high probability of failure and the continuing cost of trying to kick-start failure after failure of a debt snowball by paying the higher interest first.

And the comments above about his audience being “uneducated” or not having degrees is total B.S. I believe it is just the opposite. The vast majority of the people that call his show are people that have graduated college and now are working have student loan debt that they don’t know how to pay down, along with their 2-3 cars, credit card debt and \$300K homes. The lower income callers are definitely in the minority. Doctors and lawyers call every single day because they are drowning in debt. So that “uneducated” audience assumption is totally wrong.

Also, he does NOT ignore when you have such a high interest on a large balance. He is constantly advising people to move high interest debt to lower interest rates in most cases.

Yes, he is a teacher, and God bless him for that.

My question to people is this: If your household income is \$100K/year and you have an emergency fund of 6 months, why do you see the need to keep your credit cards and go into debt? It makes no sense, for ANY income.

My \$.02.

• JOE March 31, 2011, 1:57 pm

You offer some very well reasoned insight. Much appreciated. If I wasn’t clear, I don’t object to the debt snowball, per se. My exact objection is to a quote, on his site, in which he dismisses the mathematically better way as though it were wrong. I’m not so rigid. I will even give you the 75% success rate. Know what? I’ll give you a 100% success rate, and mine only 10%? Okay? So, my way is the right way for only 10%. I’m okay with that. These people who are disciplined and happened to have high balance high interest debt, but many low balance low interest cards will come ahead this way. Of course the key is identifying these people in advance.

We do have a good income, but my credit cards don’t put me in debt. They keep me organized, get warantee/breakage coverage, and provide rewards, cash rebate. The safety of not walking around with \$1000 in my pocket helps a bit as well. I’ve not paid a cent in interest since I was young and stupid, over 20 years now.

• Dilip Sarwate April 25, 2012, 2:31 pm

I would like to bring up a related issue that may be messy to incorporate into spreadsheets. According to the CARD Act of 2009, if only the minimum payment is made in a billing cycle, then it can be applied to the outstanding balance as the credit card company pleases. However, any amount above the minimum must be applied to the balance beginning with the highest-interest-bearing portion of the outstanding balance. So, suppose that an outstanding balance has parts bearing different interest rates (e.g. a transfer balance amount that is “interest-free” for a year plus charges from times gone by and subject to different interest rates) and that is one of the accounts getting the minimum monthly payments as per whichever snowball strategy is being followed. Then, unless the credit card companies are unusually generous, the balance bearing the lowest interest will get paid off (in part or in whole) on all cards that are getting the minimum monthly payment.

Breaking down each card balance into separate categories and choosing the optimum strategy after that is messier, and may the comparison more cloudy.

• JOE April 25, 2012, 2:56 pm

Welcome, Dilip! For my readers, Dilip is a regular at the Personal Finance and Money board at Stack Exchange. His answers are top notch, and pardon the pun, right on the money.

To this comment, I agree 100%. One would need to do their own math and spreadsheet, perhaps, to navigate the impact of the dual interest rates at play. As you suggest in your answer to the question Is it OK to use a credit card on zero-interest to pay some other credit cards with higher-interest? before borrowing at the low rate, one should clear out any higher rate debt on that card, avoiding this mixed-rate issue altogether.

In the end, I think that it’s important for one to look at the big picture and not blindly follow any rule.
Thanks for visiting, and commenting!