When you feel as though you're drowning in a sea of debt, paying off those bills can seem like an insurmountable task. But studies show a few simple changes to the way you approach your finances could help you pay down your debt and start building wealth.
Which Bill Would You Pay First?
Let's say you have four debts. Here's the breakdown:
- $200,000 mortgage at 3.5% interest (30 years)
- $20,000 car loan at 4% interest (5 years)
- $2,000 credit card bill at 18% interest ($80 minimum payment)
- $200 medical bill at 0% interest (hospital allows $10 monthly payment)
If you had extra money each month, which bill would you tackle first?
If you're looking at your debt from a mathematical perspective, you'd say the credit card bill since it has the highest interest rate. But, studies show paying off that bill first could be a mistake. Instead, you should tackle the medical bill first because it's the smallest.
The Psychology of Money
Paying off debt isn't just about math--it's about your behavior. So it's important to understand the psychology behind spending.
A 2015 study published in the Journal of Marketing Research examined which approach helps people pay off debt the fastest. Researchers discovered motivation was the key to debt elimination. As participants experienced small successes, they gained momentum in their efforts to pay off their next bill.
Paying off your debts smallest to largest--regardless of interest rate or terms--could help you gain confidence in your ability to pay off your bills. With each debt you eliminate, you'll be more motivated to tackle the next one.
Self-Control and Spending
According to NerdWallet, the average U.S. household consumer debt profile looks like this:
- Student loan- $48,986
- Mortgage loan - $171775,584
- Credit card debt - $15,310
- Auto loans - $27,188
They estimate the average U.S. household with debt owes $132,086.
A multitude of bills makes debt seem insurmountable. And when things get overwhelming, it's hard to see how applying that extra $20 or $50 toward your debt is going to help you get ahead. So you'll be more likely to splurge on dinner or concert tickets, rather than use it to pay down debt.
Just like any other major task--whether it's losing 100 pounds or earning a million dollars--you need to break debt down into smaller, more manageable chunks.
When you see your efforts are working, you'll keep going. And slowly but surely, you'll pay off your debt much faster than you would if you tackle the highest interest loan or the biggest debt first.
So start paying off your bills smallest to largest. As each debt gets eliminated, you'll be more motivated to pay off the next bill.
Getting out of debt takes mental strength. And the best way to build that strength, is to start changing your habits, one small step at a time. You'll be less likely to splurge and more likely to pay down the debt when you start seeing measurable results.