The Psychology of Paying Off Debt

Filed in archive Credit on June 13, 2006

I reviewed the new Wall Street Journal Complete Personal Finance Guidebook recently and one piece of advice struck me as interesting.

The author, Jeff Opdyke, suggests that if you have credit card debt on multiple cards, with one or two cards having rather low balances in relation to higher-balance cards, you should pay off the low-balance cards first, even if they have higher interest rates.

While it's not logical to pay off lower-interest debt before higher-interest debt, the theory here is that by paying off some of the smaller balances, you'll keep your motivation high enough to see it through until you're completely out of debt. If you're throwing money to chip away at the huge debt, the number of bills you have isn't going to get any smaller and you might not feel as satisfied or feel like you're getting anywhere (even though logically you know you are).

I've heard that David Bach, the automatic millionaire guy, gives the same advice, and I think it's sound.

When you're in debt, especially when you have debt from multiple lenders, your life can start to feel out of control. Finishing off smaller debts makes you feel like you're cleaning up your financial mess--fewer debts, fewer envelopes showing up in the mail asking for money, fewer phone calls to see when the payment's going to show up.

In truth, it's costing you a little more to tackle smaller balances with lower interest rates, but the psychological gains are so great I think it's worth a few extra dollars to employ this strategy.