Where Should You Start With Debt Repayment? Smallest Bill or Highest Rate?

by Gary Foreman

What’s the smartest way to pay down debt? Should you start with the smallest bill or highest rate first? Use these guidelines to determine the best strategy for digging your way out of a financial hole.

Dear Dollar Stretcher,
My husband and I have accumulated some credit card debt, a personal loan from my mom, and a home equity line of credit. Recently getting married, purchasing our first home, and some medical bills have really put a hurt on our budget.

Some advice that I have read says that one should pay off the debt with the highest interest rate first. Other advice says to pay off the smallest debt first and work my way up the debt ladder. I’ve even heard of a debt snowball.

Which one is the most effective in our situation?
Amy

According to the Federal Reserve, as of fall 2022 there was over $16.51 trillion in consumer debt in the U.S. So an awful lot of people are facing the very same choice. So let’s see if we can figure out what would work best for Amy.

What the math says

Let’s begin with simple math. Paying the debt with the highest interest rate will reduce the total debt quicker. The reason is clear. The higher the interest rate, the more interest is added to the balance you owe each month.

Suppose you owed money on two different accounts. The first account charges 5% interest. Paying off $1,000 would save Amy $4.17 per month in interest expense ($1,000 times 0.05 divided by 12 months).

Now suppose the second account charges 10% interest. Paying off $1,000 would save $8.33 per month. Clearly, she’ll save more, and reduce her balance quicker, if she pays off the account with the highest interest rate.

The downside to the ‘debt snowball’

The ‘debt snowball‘ method has you pay off the highest interest debt first. Then continue to make payments on the next highest interest rate until that’s completely paid off. The process is continued until all the debts are retired.

But, there is a risk to this strategy. A psychological or emotional risk. It might take Amy quite awhile to pay the entire balance of the account with the highest interest. And, after 6 or 8 months of trying, she might get discouraged and be tempted to give up if she’s still writing a check to them each month.

Let’s face it. Some people are more determined than others. And some of us need immediate feedback or gratification.

One way to get that positive feedback is to have an account disappear because it’s been entirely paid off. The fact that it’s the account with the smallest balance doesn’t matter. To our ‘feel good’ selves any account will do.

Related: 6 Legit Ways to Pay Off Debt Quickly

Choosing which debt repayment strategy is best for you

What’s best for Amy? Paying off the highest rate of interest first is the most efficient answer. But depending on Amy’s personality, paying off the one with the smallest balance might be the best answer.

Before deciding, there are other ways to get positive feedback as you pay down debts. One simple way is to watch your total indebtedness drop each month. Just list the balance on all your accounts and add them up. You may choose to graph it and watch the trend line go down.

Another way to encourage yourself is to watch the amount of interest owed drop each month. Remember that the interest you owe each month doesn’t buy you anything. It’s the price you pay for borrowing the money some time in the past.

Just list the interest charged by all of your accounts and total it. Again, compare it to the total from a few months ago. If the total amount owed is going down, so should the amount of interest that you pay each month.

Another way to encourage you to stay the course is to give yourself small rewards along the way. Nothing big. Just enough to acknowledge that you’ve met another goal.

Watching her balances drop might not be enough for Amy. She might be one of those people who won’t feel successful until she’s writing fewer checks each month. If that’s the case, she should pay off the smallest account first so she feels like she’s making progress.

Related: Staying Motivated to Dig Yourself Out of Debt

Credit cards above all others

Amy will probably find that her most expensive debt is on credit cards. The least expensive will be her mortgage. If she’s sure that they don’t have a problem with uncontrolled spending, they might even want to use a home equity loan to pay off some higher interest debt. But only if they’re not “spendaholics.”

One other strategy would be to pay off one or two of the small accounts to get started. Once Amy is past the point of needing encouragement, she can shift to paying more on the accounts with the highest interest.

Finally, it’s more important that Amy starts now. Which account she pays first is less important. Each month she delays all of the accounts add to the interest owed. The hole gets a little deeper. It’s better to pay off low interest debt, than no debt at all.

• Be Debt-Free This Year
• Consolidating Debt into a Mortgage Refinance: Will It Save You Money?
• Pay Off Debts or Save First?
• 3 Critical Tools for Paying Off Debt
• Reduce Your Debt with a Sinking Fund

Reviewed January 2023

About the Author

Gary Foreman is a former financial planner and purchasing manager who founded The Dollar Stretcher.com website and newsletters in 1996. He's the author of How to Conquer Debt No Matter How Much You Have and he's been featured in MSN Money, Yahoo Finance, Fox Business, The Nightly Business Report, US News Money, Credit.com and CreditCards.com.