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Is Dave Ramsey’s Debt Snowball the Best Way to Pay Off Debt?

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The other day I wrote about Dave Ramsey’s Debt Snowball, a method for quickly and effectively paying off your debt. The concept is fairly simple: list your balances from lowest to highest and pay minimums on each bill except for the lowest bill, to which you will send as much extra cash as possible each month. Once that bill is eliminated you use the payment you were sending to the bill you just paid off, add it to the payment you are already sending on the next lowest balance and you repeat the process until each bill has been repaid.

What’s Wrong With the Debt Snowball?

To be honest, I think the Debt Snowball is a great way to repay debt because it is organized and focused. That said, there are a couple reasons that many people have issues with this concept. The first is that Dave Ramsey recommends paying the lowest balance, regardless of the interest rate. His belief is that the quick wins will be the motivational factor most people need to keep going. Mathematically, his method is not the best, but it puts mind over matter, which is half the battle. (To those who use the math argument as a reason against using the debt snowball, also consider that paying off the lowest balance first increases cash flow, which can give people more financial flexibility).

Another issue with the Debt Snowball is there is no distinction made between secured and unsecured debt. And there can be big problems with not paying secured loans – foreclosures and repossessions being at the worst end of the spectrum.

Should the Debt Snowball Address Secured Debt?

I recently received this reader question regarding the order to repay the debts. I would normally just send a link to the debt snowball or Dave Ramsey’s Baby Steps for most similar questions about repaying debt. But in this case, I felt obligated to go against the popular money guru’s advice. I’ll share my answer, and I’m interested to know how you would handle a similar situation.

I am hammering away at my debts. In the past year I have paid off about $10,000 in debt, but still have a ways to go. I have the following debts on top of a $128,000 mortgage:

  • HELOC: $14,200 @ 10% interest,
  • Auto loan: $8,800 @ 7.55%
  • Student Loan 1: $29,000 @ 4%
  • Student Loan 2: $3,200@ 4.55%

I want to know which debt I should attack first. Also, I will most likely be getting a bonus at work in the amt of $15,000 after tax. I feel like I should eliminate that HELOC first, is that right?

Thanks for contacting me, and congratulations on making so much progress eliminating debt! There are dozens of ways you could attack your debt, but here is what I would do.

Address the secured debts first

Your bonus is a huge blessing and unless you have other pressing needs at the moment, I would recommend using it to eliminate your HELOC  (the only needs I would prioritize above this would be paying your mortgage or establishing an emergency fund to help prevent the need for taking on more debt).

So long as you are good with those two areas I would eliminate the HELOC first, for these reasons:

  1. It has the highest interest rate,
  2. It will probably increase your cash flow the most,
  3. Most importantly, your house is used as collateral for the HELOC (if you default on the HELOC you can lose your house).

It’s awesome that your bonus will enable you to eliminate the HELOC in one fell swoop. It may not be a bad idea to close the HELOC if you don’t have any need for the loan in the near future.

Next steps: After the HELOC is repaid I would still use the debt snowball concept, but again, I wouldn’t repay the lowest balance loan. I would make the minimum payments on everything except the car loan, which I would pay extra toward until it is eliminated (again, because it is a secured loan and it has the highest interest rate). Then repeat the process with your remaining loans. I would probably order them as the car loan, followed by the smaller student loan, then the larger student loan.

Final thoughts. I think DR’s Baby Steps is a great process, but HELOCs can be a dangerous type of loan because they are tied to your home. I think it’s a wise decision to pay it off right away if you have the means to do so. But there are many ways you can pay off your debt, so choose the method that you feel most comfortable with.

The key to success with this is paying extra on your debts in an organized way so you can eliminate them more quickly – an example is using a debt snowball spreadsheet to help organize your payments. You will be successful as long as you are paying extra and not adding new debt.

How would you handle repaying these loans?


Published or updated November 8, 2010.
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{ 17 comments… read them below or add one }

1 Ron

Based on the information you were given, I think I’d do exactly what you recommended. What you really need to know though, are the payment amounts. If student loan 2 was paid down from over $100,000 and had a payment amount of $450, it would get my vote for a quick payoff with the bonus money. Also, it would be helpful to know the reader’s income level in conjunction with the payment amounts as well.

But, given the state of the economy and the precarious nature of employment today, paying off that HELOC first and the car second is very good advice in my opinion.

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2 Ryan

Ron, that’s a great point. The payment size matters quite a bit. If the student loan 2 and the car loan were both in the $400 per month range, then I would probably pay them both off and use the remaining money toward the HELOC. Then I would use the extra cash flow to direct it toward the HELOC with the intent of paying it off as quickly as possible.

Creating more cash flow offers a lot of financial flexibility and can help avoid taking on more debt.

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3 Nancy

One disadvantage of paying off student loan debt first is a student loan dies with you – it does not have to be paid by your spouse, etc. So in the event of your untimely demise, your family might be better protected if you pay off your other debt first and die owing your student loans.

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4 Peter

I think the key for any situation is to examine your situation and apply what will work best for you. Even Dave Ramsey, when faced with phone calls on his radio show telling them their own preferred way to get out of debt usually ends up saying something along the lines of “you can’t go wrong getting out of debt”, or in other words, as long as you’re still making your ways towards debt freedom, you’re good to go.

I probably would have paid off that HELOC as well, although having complete information about the situation would be good too.

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5 Ryan

Agreed, Pete. Getting out of debt is moving in the right direction.

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6 JoeTaxpayer

Here’s my thought. I found a note on Dave’s site where, when asked whether to pay high rate first, he advises the low balance debt snowball instead. We can debate feelings, and whether the success of small payoffs is motivating (sure it is, I don’t dispute it), but Dave dismisses the high rate first approach in a way that I am not comfortable with.
I wrote about this and linked to a spreadsheet site that offered a comparison.
If the high balances also carry higher rates, the cost of snowball can be high. Admittedly, I can (and did) skew the numbers to make a point.
Isn’t it fair to say “be aware of the cost. If the difference is minimal, do what motivates you. If the difference is thousands of dollars over a couple years, think hard before deciding.”?

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7 Mr. Cow

I usually attribute things like this to DR’s method being an OK fit for anyone but an excellent fit for almost no one. Although I’ve never been in any kind of serious debt (less my mortgage which isn’t addressed in this section), so I guess I have no room to talk. However, I do believe that your assessment does make more sense than the smallest first approach in almost any situation.

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8 Christine | Money Funk

I think Dave Ramsey’s snowball is a great way to start, if your just on your way to debt freedom. But as time evolves, its good to do what works for you. I like the satisfaction of paying the smaller balances first. And they were usually the highest interest, too. So it worked out.

Also as time evolved, I calculated the difference in interest saved with different payoff senerios using whatsthecost.com. And went with what made best sense to me at the time. Now, I am just onto paying Student Loans. Fun (sarcasm). ;)

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9 The Happy Rock

I agree that there isn’t enough information to make a fully educated decision. Payment amounts and income/amount left each month to pay towards debt would be the two other pieces of information that I would be interested in.

Personally, I might be tempted to go with the car. I just hate car debt and it would probably clear 300-400 a month in cash flow. I would then put the rest on the HELOC. The point being is that I would chose the method that gets you the most energized and eager to kill more debt.

The thing to remember is that even if the payment was applied in normal snowball fashion, we are only talking about a couple hundred bucks in interest in a year that would be lost. Significant, but only really a few weeks of extra payments. So the motivation factor is the key IMO.

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10 Ryan

Happy Rock, you’re probably right regarding the car payment – it may be the highest of the bunch, and eliminating it would free up more cash flow, making it easier to deal with future emergencies.

If I were going that route, then I would probably go ahead and eliminate the small student loan as well, just to knock two loans off the books and increase cash flow. Then I would use the payments I was sending for the HELOC…

There really are a lot of factors to consider here!

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11 Kirk Kinder

Good advice. I would stick with what you said unless I found out more information like tax bracket, free cash flow, etc.

I wonder why the HELOC is so high. I would look to see if they can get that rate down if they can. However, I wouldn’t close the HELOC as you suggested. Having access to home equity is important unless you have no willpower and having it will cause you to overspend. I always use New Orleans as the reason. Many people who had most of their net worth tied up in their home had no access to money when Katrina hit. If they had a HELOC, they would have been able to draw on it to help them get through a tough time.

Also, the HELOC could help if they have a cash emergency. Even at 10%, it is cheaper than most credit cards, and it is deductible in many instances.

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12 Ryan

Kirk, good point. I was looking at it from the standpoint of avoiding the temptation for more debt, not the for using it as an emergency source of funds. For some people that is a fine line and should be considered on a case by case basis.

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13 Jake

I agree with Kirk. I see no issue with leaving the HELOC open after paying the balance off with that superb bonus. The rate on the loan seems quite high, so I would look into lowering it, if that is possible.

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14 Michael Harr @ TodayForward

While the minimum monthly payment amounts would be great to have in making this decision, we can generally assume that the HELOC is amortized over a longer period than the auto loan which means the payment-to-balance ratio is higher for the auto loan than the HELOC. In light of this, would definitely have recommended paying off the auto loan first to cut out the highest interest rate first and free up more cash flow (double bonus!). From there, the HELOC would be next in line because of the interest cost, impact on financial security, etc. Student loans (assuming they’re of the federal variety) would be at the back of the bus because they have a low rate and this particular type of loan has a great deal more flexibility than a HELOC in the event of major financial distress (forbearance, forgiveness, etc).

Regardless of payoff order, $15k in debt disappearing from one’s life is a great thing=)

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15 K.C.

The take-away for me is the distinction Ryan makes between secured debt and unsecured debt. It is an important distinction to make when prioritizing the retirement of debt.

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16 basicmoneytips

I guess from the standpoint that you are making progress paying off debt and it can keep you motivated, this technique is good. However, I think you need to get the most bang for your buck, and approach debt like that.

At the end of the day if this practice is what works for you, go for it.

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17 Derek

I agree – in general – with the concepts portrayed here and those that Dave Ramsey teaches. But the crux of this is, is the person getting out of debt paying diligent attention to the mathematics of it all.

First, getting out of debt is always a great thing…as mentioned multiple times in previous comments. But I allude to a second principle, which DR common pops off with in his teachings is that ‘if we were good at the math, would we even be in this situation to begin with’ [my paraphrase]. If you know the consequences of interest, compounding, revolving, collateral, etc. – most people might give it a second thought before putting their financial future on the line.

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