It depends on the effect of “feels better” and the consequences of “feels worse”.
If someone is so stressed about debt that they’re losing sleep and having problems with work and/or relationships then if doing something that “feels better” lets them sleep better, has them less stressed, motivates them to continue to reduce debt, and they function better in general then it might be the best route to take even if by the math it’s not the most advantageous because life is about more than just money. They’d still presumably be making progress to get out of debt, just not so fast as otherwise.
It’s a fine line to walk and there are arguments for and against both sides.
Obviously, it is mathematically more advantageous to pay off your high interest account first, then your lower interest account second than if you do it the other way.
However - it is mathematically less advantageous to start paying off your high interest account, get discouraged because the debt continues to feel overwhelming, and then go back to paying the minimum monthly payment than it is to pay off your smaller accounts and have the psychological boost of having paid something off to continue to reduce your debt.
Also, to go back to the first point - how much more mathematically advantageous is it with your debt load and distribution. Are you saving (potentially) hundreds of dollars/month by paying off the highest interest rates first? Or is it more along the line of $500 over a 10 year period - or $5/month? Obviously, 5 is more than 0 - but it may be worth the price for peace of mind, motivation, and yes, to feel better. (I personally know that at various times I have paid a lot more than $5 to feel better. And it has been worth every penny.)
I think it’s important to be brutally honest with yourself “this is what I owe. This is what it costs me in terms of money, time, stress, lost opportunities, gained opportunities, emotional stability, etc. This is how I benefit from the status quo. And this is what a change will do for me in terms of all of those factors” So that you can be deliberate about the choice that you’ve made.
People keep explaining this as if I don’t understand it. I get it. I am just challenging its value. Or rather, I am encouraging others to closely scrutinize the proposition.
If your goal is “I want to waste as little as possible on interest, and exit debt as rapidly as possible” then you pay off the highest interest first. Full stop.
If your goal is “I’d like to stay in debt longer and pay more interest than I need, but be comforted by the fact that I have fewer open accounts,” then you retire the thing with the smaller balance.
Obviously I have a preference, but I’m not trying to sell anyone on it. I would just suggest that anyone facing this decision tally up the cost of each approach and decide whether that “psychological benefit” is really worth paying $10,000 for (or whatever).
There are cases where I’ve done this (prioritized account closures), but the premium I put on this approach is extremely, vanishingly small. Like less than $100.
So, the reason I keep explaining it is that there’s a large gulf between what I intended to convey and your restatement/rephrase. And it makes me think that I wasn’t clear enough, not just for you - but for other people who might be reading the thread who might be making decisions about debt.
It is very clear that should you ever be faced with this situation, you will always pay off the highest interest rate first.
I’m not sure that waiting for the housing market to cool off is a good idea. Home values will flatten, but they hardly ever go down (2008 being an exception to the rule).
Refinancing the car loan is free money. No outlay required, no dipping into your cash reserves, but you get extra money every month.
There’s no such thing as “refinancing” credit card debit, though (other than using home equity to pay it off, which you don’t have). So pay those cc bills asap.
Things that improve your credit score: making payments on time (check); having a high ratio of available credit to outstanding loan balance (will be the case, when the cc’s are paid off); not having a lot of inquiries (don’t open any new credit).
I agree with this. It’s important to know what the trade - off actually is in real dollars. Is the “peace of mind” of living debt free worth losing $300,000 in potential dividends from not investing? Everyone is going to have a different price point.
I think another factor too is cash flow. The math might point to paying off the high interest debt first, but maybe paying off the low interest one frees up the most dollars (as is the case with our car loan.) I don’t like having money spent before I even get it. The more flexible my dollars, the happier I am. But that is a happiness I am in effect purchasing with the difference in interest rate.
There sort of is - look at the proliferation of “balance transfer” offers. But you have to take those VERY carefully. There may be a fee (e.g. 3% of the transfer amount - which on, say, 10,000 is 300 bucks). The new card’s rate might be only good for a year - so you have to save enough in one year to make up for the that 3%. Going from 24% to, say, 12% for a year, then back up to 24% after a year may save you a little in the short term but you’ve also paid that extra 300 bucks.
People who deny they are influenced by the psychology of it might make the wrong decision because their decision making process if flawed. The issue is not what to do, it is how to convince oneself that you should do it.
I’ve been in many discussions on why it is good to pay off a mortgage early even though it doesn’t make financial sense.
After all, in many cases (not all for sure) people get themselves into debt because of poor psychology. Why expect them to get themselves out because of it.
My daughter got into this field because her future father-in-law decided that the first thing to do after getting fired was to buy a new car. She didn’t understand and wanted to.
Okay. How, specifically, do you apply this principle apply to the decision of whether to forego savings in order to retire a specific account that isn’t the best return on investment? What is the right decision per your above analysis? How do you rationalize that?
If we say “my student loan has the lowest interest rate of all my loans, but I’ll pay it first because this specific loan somehow makes me feel bad”, this is a perfect example of psychologically flawed, emotionally-driven reasoning. You’re seeing a certain psychological bias that makes you lose money, and (it sounds like) instead of challenging it by running the numbers, you wave your hands and say “this is somehow better”.
There are only 2 choices here. Either I make more money, or I make less money. If I choose less money, then I need a compelling reason to do so, and nobody’s offering any concrete advantage other than “something something flawed human psychology.”
And look, I get it. Recently I bought an expensive car because I like this expensive car. It’s far more than I need to get from point A to B. I assessed “I like what I like” and spent money unnecessarily. Paying off annoying but low-interest loans is in exactly the same category. In fact I dream of paying off my mortgage more than makes rational sense. But I don’t deceive myself into thinking it’s a canny wealthy-building strategy. It would be wasting money on something because, as a flawed human, wasting money on certain things makes me feel good.
Where the psychological bias plays a role is in how likely it is somebody will continue to keep up good financial habits.
If, without that psychological boost, people are only 25% likely to sustain an optimal investment plan but 75% likely to sustain a sub-optimal (though still good one) with a few of these boosts, that drastically changes the math.
Everybody in the thread appears to agree that paying off the high interest debt first is the best thing to do. On the other hand, human beings are notoriously bad at making strictly rational decisions and sticking to them. On the gripping hand, it is difficult, bordering on impossible, to model these psychological factors to factor them into investment decisions to optimize behavior.
Sure, it’s nice to have tractable problems with clear assumptions and optimal solutions but that’s just not the way people work. It would be nice if they did but we have to work with the world we have, not the world of spherical cows.
But nobody’s demonstrated that this is the case! Of course, intuitively it seems reasonable enough… but folks are insisting that we can’t rely on intuition because human psychology is so fatally flawed! Both can’t be true.
Why dig in so hard on the unproven assumption that pursuing a sub-optimal financial plan will help someone pursue a better plan later?
It seems like the deeper truth here is that the psychology of debt reduction really isn’t 100% about being wealthier. It’s partially about the joys of being psychologically unburdened. It makes total sense. Money helps us solve problems, and bad feelings are a legitimate problem to solve with money. But we shouldn’t confuse it with a strategy for getting richer, because they’re different things.
This is just underpants-gnome silliness. I’m talking about counting real, actual dollars that go in your real, actual bank account. You folks are the ones hand-waving the hidden steps with a strategy that nobody can seem to demonstrate that it works outside of their own intuition.
Even ostensibly ‘rational’ investors aren’t all that rational. This is basically Rational Choice Theory and the Invisible Hand, which is known to have problems, even for ostensibly rationale actors, like corporate investors.
It’s known not to be all that reliable even for those who are supposedly trained to behave rationally. Expecting those who are untrained to follow those models defies reality in favor of disproven theory. It’s not hand-waving at all to disfavor theory in favor of empirical results.
So, the “optimal” solution is one we can’t discover yet - how to optimize in the face of human psychology. Expecting people to behave “rationally” is itself irrational, and this is borne out in the research.
Sorry, the argument we’re having here is not whether humans are rational or not. I understand that this is an easier and more convenient point to argue, but I’ve already stipulated it to the point of exhaustion because it’s not the question under consideration. Want me to say it again? Humans are irrational idiots. They waste money on things that make them feel good. I waste money on things that make me feel good. Am I getting through?
For some reason I’ve needed to stipulate that fact several times. I’m sure I’ll have to stipulate it again, multiple times, if I continue in this thread. If you want an example of flawed human psychology, reflect on that one.
I get that closing out loans feels good even if it’s inefficient. I’ve done it myself in the past, I’ll probably do it again in the future, because I prioritize feeling good. But I don’t deceive myself into thinking that this serves to optimize my financial gain. Nobody in his thread has demonstrated that doing this leads to better financial behaviors later. Everybody’s insisting that since it intuitively works in their head, it probably works in the real world. I want to see the evidence.
I don’t think that the financial issue most people face is which loan to pay off. There is often a clear and obvious financial choice that is best. If someone makes the illogical choice to pay off a 3% mortgage rather than a 14% CC, then likely they have some irrational reason for making that choice and I’m not sure they can be talked out of it. Rather, the unsure choice most people face is whether to put money towards paying off loans with a simple financial benefit or invest it in something that has an uncertain return. Whether someone should pay off their mortgage early or invest in the stock market does not have a clear answer. We can look at history and say that they will likely make more in the stock market compared to the interest on their mortgage, but that is not a sure thing. The market has crashed before and it probably will again. But the impressive gains in the stock market means that it’s generally a better choice to take your chances in the market.
I remember the runnup of the stock market and hearing friends and coworkers say that the market was too high as it went over 4000, 5000, 6000, etc. They were worried it was going to crash and they took their money out. But the crash didn’t really come and now the market is over 30000. Maybe the fear of losing their money was too great and it was worth it for their mental health to get out of the market even though they could have multiplied their money many times over.
You seem to be creating a strawman to argue against.
AFAIK, people in the thread have not claimed this behavior was optimal (however ‘optimal’ is getting defined) or would lead to optimal behavior but rather that it’s the “best” thing for them to do now depending on their tolerance for risk and the inherent uncertainties in investment and their own personal behaviors.
This is exactly the issue I’m trying to delineate here. In this case, the real math is unknown. We can guess how much return we’ll get on investments, but there’s always the risk we will miscalculate.
And to the extent I am making a claim (which I suppose I am), it is that there exist a non-negligible number of people who cannot follow best practices in terms of investment but it still behooves us to consider the best advice to give them. Whether that should be placed under psychology or economics or whatever, it doesn’t much matter.
If the concept that such people exist requires a peer-reviewed paper to verify, I am at a loss on how to respond to that.
If you want to retreat to the most easily defended position, cool. But you still haven’t addressed what that best advice actually is, or how you can prove that your advice is better than a different approach for those people, or even how that advice is supposed to get them out of debt faster.
As I predicted, I must now reiterate that I don’t contest the existence of human fallibility.
I’m asking you to explain what approach you think is best for those people, and how you define “best”, and how you can prove that your approach is best. Don’t need a peer-reviewed paper, just tell me how you see this approach leading to more wealth.
All I’m hearing is “some people are irrational and maybe math won’t work for them.” Fine. Nobody has to calculate anything. It’s a rule of thumb, just follow it! Pay off the highest interest rate first, follow this advice mindlessly without questioning it, and you’ll get out of debt faster than the alternatives. And if one does need to question this, then the proof for it exists.