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Financial Face-Off: What’s the best way to get rid of credit-card debt — pay off the smallest balance first or the one with the highest interest rate?

Hello and welcome to Financial Face-off, a MarketWatch column that helps you weigh financial decisions. Our columnist will give her verdict. Tell us whether you think she’s right in the comments. We want to hear from you. Share your suggestions for future Financial Face-off columns by emailing our columnist at lalbrecht@marketwatch.com. 

The face-off

It’s a new year and a new you. If you’re carrying a credit-card balance or other unsecured debt, you may have decided that now is a good time to start the journey toward becoming debt-free.

There are two popular methods for getting rid of debt: the debt snowball and the debt avalanche.

The snowball targets your lowest-balance debts first. With this method you pay the minimum on all of your debts, and put extra money toward the lowest-balance debt until it’s paid off. Then you cross it off the list and put even more extra money (because you’ve eliminated a debt payment) toward the next lowest balance. 

The avalanche tackles the debt with the highest interest rate first, regardless of balance size. You use the same pay-off method, but focus first on the most expensive debt. 

So what makes more sense for people trying to get out of debt: the avalanche or the snowball?

“The debt avalanche method is the most cost efficient as you start by paying off debt with the highest interest rate, but it can be intimidating and harder to stay motivated when you start with the larger balance,” said Carrie Schwab-Pomerantz, president and board chair of the Charles Schwab Foundation. On the flip side, the snowball “can provide a psychological boost when you see some of your debt eliminated, but you may end up paying more in interest.”

Why it matters

Americans’ credit-card balances have swelled to record totals as they turn to credit cards to cope with high inflation. A recent Bankrate survey showed that more than one-third (35%) of U.S. adults now carry credit-card debt from month to month, up from 29% last year. The average card balance per borrower was $5,474 as of the third quarter of 2022, according to TransUnion
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To make matters worse, credit-card debt is more expensive than ever. The average annual percentage rate (APR) on a credit card recently hit 19.85%, an all-time high, Bankrate says

If you made the minimum payment of $141 on the average balance of $5,474 with a 19% APR, it would take more than 23 years to eliminate that debt, during which time you’d pay $8,073 in interest, according to Bankrate’s calculator

Meanwhile a recession may or may not be looming and layoffs have been occurring at a growing list of companies. The time to get rid of any debt you’re carrying is now.

The verdict

It will probably cost more money and time in the long run, but I’m going with the snowball method — paying off the smallest debt first.

My reasons

In choosing the snowball method, I’m thinking of people whose debt has put them into a dark hole that they can’t see out of. By providing early wins and the sense of accomplishment that comes from crossing a debt off the list, the debt snowball shines a ray of light that can guide people to freedom from debt.

This isn’t just a hunch. Research published in Harvard Business Review and by Northwestern’s Kellogg School of Management back up the idea that the snowball strategy could be more effective because of the motivation it provides.

“Personal finance is 80% behavior,” said Rachel Cruze, host of The Rachel Cruze Show and daughter of personal finance expert Dave Ramsey. “We try to go at our money so often with math. But it’s not a math problem, it’s a ‘you’ problem.”

Like her dad, Cruze is a fan of the snowball method. For people who are living paycheck to paycheck and overwhelmed by debt, digging out can feel hopeless. “What the debt snowball does is it inserts hope early on,” Cruze told MarketWatch. Even paying off a $400 interest-free loan from your mom before a $3,000 credit-card balance with a high interest rate can give someone the momentum to keep going, she said.  “Suddenly hope starts to come into your language and into your spirit and you think, ‘OK, I really can do this.’” 

Cruze has noticed that people who call into her dad’s show don’t mention math formulas when they describe the process of paying off their debt. Their language is emotional and describes feelings like anger.  “They say, ‘We got mad, we were sick and tired, and we were going after it. As those smallest [debts] get knocked off, you get madder and madder, probably until the student loan, which is usually the last one because it’s usually the highest for people,” she said. “It’s powerful and it works.”

Debt can be paralyzing, Cruze said, negatively affecting people’s mental health, sleep and marriages. “When you owe someone money, someone has a say over your life and over your income,” Cruze said. “Credit cards have done a fabulous job of marketing to the American people through points and airline miles, and this idea you can play this game and get free stuff. And what it’s led to is a lot of bondage.”

She added, “The relief and the amount of peace that you have when you’re controlling your money vs. your money controlling you is everything.”

Is my verdict best for you?

On the other hand, the debt avalanche method is the mathematically correct answer. Getting rid of the most expensive debt first will cost less money and time in the long run.

The avalanche strategy directly attacks one of the “insidious” drivers of debt, which is the cost of money, and that in turn targets another core driver of debt: time, said Perry Wright, a senior behavioral researcher at Duke University’s Common Cents Lab, which partners with nonprofits, financial institutions, fintechs and other groups to study how consumers behave with their money in real-world situations. 

“The longer it takes [to pay off], the more expensive it is, and the more expensive it is, the longer it takes. These two things interoperate and create these cycles of debt that are so hard to get out of,” Wright said.

However, while the debt avalanche is more efficient, the trade-off is that it’s not as motivating. Because it may take months or years to pay off a large balance, you’re not going to get the satisfaction of crossing an account off your debt list as often.

Research has shown that eliminating a single debt account is actually more satisfying to people than making more progress toward paying off all of their debts, Wright noted. This is a behavior known as “debt account aversion.” It’s also true that people step up their actions toward meeting a goal when they get close to the finish line, a phenomenon known as the “goal gradient” effect, Wright said. The snowball method lets people sprint to a finish line more often.

But both the snowball and avalanche method have their merits, and both are better than just making the minimum payments on everything, Wright said. Research on “multiple goal pursuit” has shown that when people try to save money for a bunch of different goals, they save less than when they just focus on one savings goal. Both snowball and avalanche provide that focus. 

As Yale University economist James Choi told MarketWatch in a recent podcast interview about popular financial advice, academics would say the snowball vs. avalanche question boils down to a simple math problem. As such, economists would advise paying down the highestinterest debt first. But that calculation ignores the power of motivation, he noted. 

“At the end of the day, I do think that the best diet is the one that you can stick to,” Choi said. “So if, indeed, the debt snowball helps you stay motivated to pay down debt, then yeah, you should go for it.”

Tell us in the comments which option should win in this Financial Face-off. Need help making a financial decision? Share your ideas for future Financial Face-off columns by sending me an email at lalbrecht@marketwatch.com.

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