Hacker News Reader

Comment by social_quotient | Hacker News Reader

On #2 What’s the rationale in not paying off the highest interest debt first? And instead go by size. Is it decreasing the count debtors feels better to make a better habit or is there a. Math reason I’m missing?

View on HN

There’s a psychological reason you’re missing: getting to that first debt paid off and experiencing that bit of joy and pride in accomplishment, in order to reinforce new habits.

If the people turning to Ramsey for financial advice were, by and large, analytical types, they probably wouldn’t need to be turning to Ramsey for financial advice.

Would it be better to push more money to a $7000 debt at 7% than a $1000 one at 5%? Analytically, yes.

Is it more likely that someone who had become nihilistic about their financial situation will actually get both of those paid off if they get to see that $1000 account “paid in full” in two or three months? That’s what Ramsey has bet on, and apparently is right about.

Financial safety is generally more about cash flow than how it’s typically portrayed, and so paying off (even lower interest) smaller loans first increases your resilience to unexpected expenses (because your cash flow is more flexible now).

There’s a psychological reason too (already commented on by others here), but there is a math reason too (cash flow).

I think it is purely psychological. It feels really good to pay off a debt, and might help people stick to it.

Exactly. Early "wins" make you more likely to stick with it.

The math doesn't work out if you give up before paying off that high-interest debt.

Exactly, the feeling of paying off one debt completely have a momentum building/forward progress to it.

It would be interesting to do the math on it.

Say you have a debt payment budget of $500 / month for payments of $80, $100 and $200. Also, for sake of the example assume that the amount owed on each is proportional to the payment size (smallest to largest).

You have a total of $380 with an extra $120 to apply to one of the payments. You’ll apply it to the $80 payment until it’s paid off so you’re now paying $200 / month towards it.

Once it’s paid off, you focus on the $100 / month but because the $80 has been paid off you now have an extra $200 / month so you can pay $300 / month today towards it.

Once that is paid off, you can now focus the entire $500 towards the $200 / month payment.

It would be interesting to see some models.

A highest-interest-first strategy definitely sounds optimal, assuming one can survive the hurdles during that time period.

For messier situations, I wonder if a better short-term paydown strategy is to maximize liquidity.

E.g., suppose a person's debt is: (a) ($500/month, 3% interest, 3 months remaining) + (b) ($2000/month, 6% interest, 20 years remaining), and they're barely making ends meet each month. Prioritizing the paydown of (a) could eliminate a lot of psychological/financial stress by reducing the risk of a cash crunch.

It's based on the idea that some sort of reward psychology matters more than perfect maximization, and probably mostly works well because usually larger debts have lower interest rates than smaller debts most of the time. (Not endorsing or rejecting.)

It's psychological — one debt gone is a brick off the mental load, and encouragement to keep going rather than continuing to peck at the mountain. The second-largest then doesn't look so big, etc., etc.

Mathematically ideal solution vs good enough and implementable now solution.

Smallest debt first is not mathematically optimal but it's more tractable for people. And once you kick the little debts that's only costing you small monthly payments that gives you more financial stability making paying off the other debts easier.

I don’t read/follow Dave Ramsey, but maybe the best method is to focus on the largest interest payment instead of the largest principal amount. That would optimise for both at the same time.

Reply on news.ycombinator.com