Great Debates: Debt Repayment

One of the greatest challenges facing many people is debt repayment.  This isn’t surprising, given the proliferation of credit cards and other forms of lending that have been fairly common over the last decade.  One of the few good points of the recent economic contraction is that the credit crunch has forced everyone to rethink the debt culture in which we have been living.

With so much debt, there are plenty of debt repayment plans.  Three big plans are widely publicized and touted, including the high interest plan, Dave Ramsey’s plan, and David Bach’s plan.  There are advantages and disadvantages to each.  Here’s a quick summary, for those of you who haven’t encountered these plans:

1) High Interest Plan – The rationale behind this plan is simple: pay down the debts with the highest interest rates first, while making only the minimum payments on all the other debts.  Then, when highest interest rate debt is gone, the money used to pay it down will be put towards the next highest debt, and the next highest, and the next highest, until all the debts have been extinguished.

Pros: This is the quickest plan; paying off the highest interest rate debt first results in the debts being discharged as quickly as possible.

Cons: Depending on how much money is at the highest interest rate, this method may take the longest to result in the complete elimination of the first debt.  If that’s the case, it might be somewhat disheartening to someone attempting to eliminate the debt.

2) The Dave Ramsey (Debt Snowball) Method: Dave Ramsey recommends starting with the smallest debt and concentrating on paying that down first, while making the minimum payments on the other debts.  Then, when the smallest debt is gone, you can add those payments towards eliminating the next smallestdebt and so on, until all the debts are gone.

Pros: This method will lead to eliminating the first debt as fast as possible, which can be a huge ego boost.

Cons: Unless the smallest debt also has the highest interest rate, you’ll be paying more in interest, and taking a longer period of time, to eliminate all your debts.

3) The David Bach (DOLP) Method: David Bach presents a third method of paying down debts, called Dead On Last Payment (or DOLP).  Essentially, you divide the amount of money you owe on a particular debt by the minimum payment, giving a DOLP score; if you owe $1000 to Visa with a minimum payment of $25, that would have a DOLP score of 40.  You then arrange the debts from lowest DOLP score to highest, and pay them off in that order.

Pros: You’ll pay off the first debt faster than with the High Interest plan (though, perhaps not as fast as the Debt Snowball method).

Cons: If the lowest DOLP score isn’t the debt with the highest interest rate, you’ll end up paying more than the High Interest plan.

My view: As you con probably tell by looking through the pros and cons, the only advantage I can see for either Dave Ramsey’s or David Bach’s plan is that it gives you your first taste of completely eliminating a debt quicker.  The financially optimal plan (in that it will save you the most money on debt repayment) is the High Interest Plan, and that’s the best option for most people.

If you need the psychological boost that comes from paying off a debt quickly, you could consider one of the other two plans.  Better yet, find a fairly small debt, and devote part of your debt repayment money to knocking that off, while the rest goes to making the minimum payments and paying down the highest interest debt.  You’ll get a quick psychological boost by knocking out the small debt, while still chipping away at the highest interest debt.

No matter what method you choose, though, know that you will be in far better shape than the millions of people who aren’t paying down their debt at all.

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