As a bankruptcy attorney, I spend plenty of time going over strategies with potential clients on how to pay down debt. I often watch shows like Suze Orman and have myself completed Dave Ramsey's Financial Peace University. Not only do I find both of these individuals interesting, but I sometimes am able to get ideas from them to help me better advise my clients. This weekend on Suze Orman's show she discussed her opinion on the best strategy for paying down debt. I quickly realized that Suze Orman and Dave Ramsey have completely different views on this matter, so I thought it would make for a good discussion. First things first.....let me explain each position.
Suze Orman
As Suze Orman discussed on her show this weekend, she believes that all debts should be listed from highest interest rate to lowest interest rate. Then, you should try to contact each company and try to negotiate a lower interest rate, although Suze acknowledges that it is likely going to be a futile attempt. Once you have called all of the companies, redo your list (if necessary) and pay the minimum payment on all debts. Take any extra funds you have and pay it on the account with the highest interest rate. Once you have paid off the highest interest rate debt move on to the next until you have paid them all off.
Dave Ramsey
Dave Ramsey also believes in making a list. However, he wants you to list your debts in order from the lowest to the highest amounts, not taking the interest rates into consideration. He then says you should make the minimum payment on all of the debts and make as large of a payment as possible on the smallest debt. Once the smallest debt is knocked out you should go to the next debt. Dave Ramsey refers to this method as a "debt snowball" and believes that this method helps people to see progress in paying down their debt which helps them to stick with it.
As a side note, Suze presently preaches that you should have 8 months of net income in an emergency fund before beginning to pay off your debts. Dave Ramsey believes that most should have $1,000.00 in the bank prior to beginning the debt snowball, but reduces the number for those on modest incomes. And one thing that Suze didn't mention is that you have to stop incurring more debt. Debt reduction doesn't work unless you stop using the cards! Nothing will frustrate you more than making large payments, but not seeing a reduction in balances due to new charges.
Since watching Suze Orman I have been thinking about which method I believe to be the best approach for those attempting to get themselves out of debt, whether it be out of necessity to avoid bankruptcy or just to live a more debt-free lifestyle. And, as shocking as it may be to hear this from an attorney....I have decided that it depends.
I know the math people out there are reading this right now and thinking that I am crazy. The math clearly agrees with Suze's method. You really should end up paying less money in interest according to Suze's method and therefore should pay off your debt much more quickly.
However, after spending years meeting with people who have been attempting to pay off their debts...and sometimes ending up in bankruptcy, I cannot discount the psychology of seeing progress in a debt snowball. Lets be honest. Suze Orman's method is not rocket science. It is not something that each and every person is not able to figure out on his or her own. So why aren't more people able to do it??? Because it is hard to deny yourself. It is hard not to continue to use credit while attempting to get yourself out of debt. It is hard to see the light at the end of the tunnel using this method. However, if you are writing fewer and fewer checks to creditors each month, you are seeing real progress toward making yourself debt free and I believe that goes a long way to helping keep up the discipline it takes to get out from under debt. But I am not saying that Suze is all wrong.....it just depends on the situation and the person.
For example, lets assume that Sally has 3 credit cards. One has a balance of $10,000.00 at 11% interest, the second has a balance of $13,000.00 at 7% interest and the third has a balance of $12,000.00 at 12% interest. In my opinion, the only way to pay down this debt is with the Suze method. There is just not enough difference in the amounts to justify paying the lowest amount first. There would be no "psychological benefit" because all three of these amounts are so close that they would each take about the same amount of time to pay off. Therefore, you should pay the debt with the highest interest rate first.
However, lets take another example and say that George has 7 credit cards (this is not at all uncommon in my experience) with the following balances and interest rates:
$750.00 at 20%
$550.00 at 10%
$5,000.00 at 15%
$1,200.00 at 9%
$800.00 at 9%
$10,000.00 at 11%
$350.00 at 20%
In George's situation, I believe it would likely be better to start paying on the $350.00 debt first, then to move up the chain based on the amount owed instead of the interest rate. George could likely pay off several of these debts in a very short amount of time, allowing himself to see real progress towards getting out of debt and I believe that this might help him stay on track to get completely out of debt. In addition, by knocking out a few of the creditors early, he has fewer payments to make. This means fewer opportunities to make a late payment which will add a late fee and a higher interest rate.
Of course, whether to use the Suze or the Dave method also depends on you. You have to take a close look at yourself and decide whether you believe you will be more encouraged to get out of debt by seeing the interest payments you are saving yourself or by seeing the number of creditors drop off of the list. The decision is going to be different from person to person. I'd love to hear comments about which method you believe would work best to pay down debt and why.
For some people, neither the Suze Orman nor the Dave Ramsey method will work. I am talking about the people who just don't have enough funds to make even the minimum payments on their debt and don't see that situation changing. These people are having lawsuits filed against them and are facing wage garnishment. If you are stressed out about debt, sick of collection calls and facing lawsuits bankruptcy may be a good option. I am willing to meet with those in Indianapolis and central Indiana about bankruptcy without judgment free of charge. Please contact me if you would like to set up a meeting to talk about your problems and find out whether bankruptcy might help you put your debts behind you or call (317) 575-8222.
Halcomb Singler, LLP, is a debt relief agency. It helps people file for bankruptcy under the bankruptcy code. No attorney-client relationship with the firm of Halcomb Singler, LLP, is created through this blog. Also, please note that Erika Singler is an attorney licensed in Indiana and does not seek to practice law in any jurisdiction in which they are not properly authorized to do so. The information contained in this blog is general in nature and should not be relied upon for the circumstances of any individual(s) or businesses.
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