Debt Repayment Test

On Monday, I discussed several popular methods for paying off your debts.  In the course of that discussion, I mentioned that paying off the accounts according to the interest they charge is the most effective method, while Dave Ramsey's method (the Debt Snowball, or paying off the lowest balance account first) and David Bach's method (the Dead On Last Payment or DOLP(R) Method, paying down the balances based on the total balance and minimum payment required) may require more time and money.

Well, today I'm going to throw in some hard numbers to back that assertion up.  I created four different credit card debt repayment scenarios, and calculated how long it would take to pay off the debt under each one.  First, a few explanations for the terms I used in each test:

  • Card Name: This is pretty obvious; I used three fictional Credit Card companies, Vesta, Servant Card, and Canadian Express for this experiment.
  • Interest Rate: The APR charged by the credit card; I made the test a bit more realistic by compounding the interest rate monthly, rather than yearly.  (I could have done it daily, as most credit card companies do, but that would have greatly complicated my calculations and made only a slight differences to the end results.)
  • Repay Percent: Most credit base the minimum payment amount on a tiny percentage of your overall balance, so I chose several repayment values on which to base my calculations.
  • Starting Debt: Pretty straight-forward; this is the amount of debt held at the start of the experiment.  For the sake of simplicity, I made the total debt for each test equal to $30,000.  (Which, sadly, is not an unreasonable amount of credit card debt for an average American family.)
  • Initial Repayment: The amount the credit card company requires for their minimum payment, equal to the starting debt multiplied by the repayment percentage.
  • DOLP: A quick calculation of the DOLP score for David Bach's repayment plans, it's equal to the starting debt divided by the initial repayment amount.  (It's also equal to 100 divided by the repayment percentage, meaning a higher repayment percentage leads to a lower DOLP score.)
  • Money Available for Debt Repayment: For the sake of simplicity, I assumed that a total of $1000 would be used each month for credit card payments.  This is the amount left after making the minimum payments to all the cards, and it is applied according to the rules for each repayment plan.

For each test, I will list the number of months it takes to pay off one of the debts, as well as the months to pay off all the debts.  The three methods I tested are paying off the card with the highest interest rate first (High Interest), following Dave Ramsey's Debt Snowball method (Lowest Balance) and David Bach's Dead On Last Payment (DOLP Method).  On to the tests!

Scenario 1:


Here, our highest interest rate card has the highest amount of debt and our lowest interest rate card has the lowest balance, so our Lowest Balance method will be paying off the debts in the opposite order compared to our High Interest method.  Our lowest DOLP value (with the highest Repay Percent) matches our Lowest Balance, so both of those methods will be in sync.  And our results are:


The Lowest Balance and DOLP methods give a fairly quick victory, eliminating the first debt a full 25 months sooner than the High Interest method.  But, the High Interest method has the last laugh, knocking out all the debt six months quicker than the other two techniques.  And, quicker debt elimination means quicker debt freedom and less money spent on interest.

Scenario 2:


Here, we've just reversed the amount of starting debt for the Vesta and Canadian Express cards.  As a result, both the High Interest and the Lowest Balance methods will lead us to knock off the Vesta debt first, while the high repayment rate (and low DOLP) will have our DOLP money going to Canadian Express first.  Which technique leads to debt freedom first?


This time, the High Interest (and Lowest Balance) technique eliminates both the first debt and all of the debts the fastest.  The DOLP method isn't too far behind, but why pay more money and spend more time eliminating your debt if you don't have to?

Scenario 3:


For this scenario, we've reversed the order of the repayment percentages; now, the high interest rate Vesta requires the highest initial repayment rate and has the lowest DOLP.  As a result, that will be first target for both the DOLP method and the High Interest method.  However, the Lowest Balance method will be focused on the Canadian Express debt first.  Which leads to the fastest repayment?


As you've probably come to expect, the Lowest Balance method retires one debt sooner than the other two methods, but takes five months longer to complete eliminate the credit card debt.  The High Interest method (in this case, tied with the DOLP method) is the fastest for debt elimination again.

Scenario 4:


For this test, we have a trifecta: Vesta has the highest interest rate, the lowest starting debt, and the lowest DOLP score; all threee methods tell us to pay that off first.


As you probably guessed, all three debt repayment schemes generated the same results in this case; each is equally effective in paying down the debt.


The big lesson from this test: paying down the debt with the highest interest rate first IS the quickest way to completely eliminate your debt.  The other two methods only match(but never exceed) the rate of debt repayment when the order of debt repayment they recommend matches the highest to lowest order of the interest rates.  While it is possible to pay down one debt faster using one of the other methods (especially, starting with the smallest balance), you'll end up paying for it in the end, as it will require more time and money to knock off the remaining debts.  Keep that in mind, and the potentially long process of eliminating the first debt should be easier to handle.

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