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Lesson 4: Debt

# High rate vs snowball method

If you have multiple forms of debt, how should you prioritize repayment? This video analyzes two popular strategies for debt repayment to determine which will cost less money over time.

## Want to join the conversation?

• I don't understand why the High Rate Method is the most mathematically optimal. A \$500 debt with 15% APR will incur less interest than \$2000 of debt with 10% APR. In the former, you would incur \$75 of interest a year; in the latter, you would incur \$200 of interest a year even though it has a smaller APR. So wouldn't the optimal way to be pay off the debt balance with the highest interest payment overall after accounting for APR * debt?
• I think it varies depending on how long you have the loan. So you would be right, and it really depends on the situation.
• Does it still make sense to be saving during the time you have debt?
• I'd say yes, at least enough to establish an emergency fund so the next unexpected expense doesn't just add to your debt.
(1 vote)
• Did you imply the Snowball works this way? With Snowball, after the credit card is paid, you then have \$120 to put toward Loan A each month. After Loan A is paid, you have \$195 to put toward Loan B each month. After the first 3 debts are paid, you will be paying \$300 a month toward that final Retail Card debt. Psychologically you see not only the individual debts being paid off faster, but feel the difference of making larger and larger snowball payments toward the next debt. Eventually you have that extra \$300 of your own money to spend, save, invest as you want every month for as long as you stay debt free!
• That is precisely how it works. You got it.
• If he's only paying \$20 (by the credit card debt, for example), its still goin up 15% [(500-20)x1.15=552]. The same is by all other debts. So how does he ever pay up his debt, it keeps growing?
• The payments in the example are monthly payments, while the interest rate given is annual. So for the credit card in the example, the annual interest on a \$500 balance is 0.15 * \$500 = \$75, which is less than 12 months of minimum payments, which would be \$20 * 12 = \$240. That being said, the retail card in the example is strange in that the annual interest on a \$4000 balance is \$1200, while the minimum payments only total \$360, so if you made just the minimum payment, your retail card debt would be ballooning out of control.
• how do I calculate how long it will take to pay off my debts
• Also on Microsoft Word, Publisher, and Powerpoint documents.
• how do you solve APR with?
• Assuming I started all these debts on the same day, (using the high rate method) what would the equation be for me to pay all the debts, plus the \$3,904 interest in total in 47 months? I'm confused about the APR, as the APR starts when you're unable to pay off the balance on time and grace periods aren't shown in the video
• So, Jay, I watched the video and I'm just going to trust the teacher for the math. I cannot offer you an equation. There are just too many distinct computations. The lesson exists to compare two methods, one of which is more mathematically satisfying, and the other more psychologically satisfying. It shows how the "pyschologically satisfying" method costs you more.

The grace period on any of these debts is likely to be only a matter of 3 or 4 weeks, so that is negligible.
Paying off "on time" just means that you make your monthly payments and incur interest on the unpaid balance.
Don't treat paying of interest with a penalty. Interest, in this case, is "RENT" for the money you have borrowed. In that way, it's like what you have to pay if you rent an apartment (which belongs to someone else) or rent a car (which belongs to someone else). What's going on here is that you are using money that belongs to someone else, and you are paying rent on it.

When we get all caught up in the idea that debt must be paid off in full before we incur any interest, we are going backwards economically.
• What's a retail card?
• You posted this question 10 hours ago. Upon seeing it a few minutes ago, I used a popular search engine and typed "retail card" into the search box. (If your parents allow you to use search engines, you could do this too.) Now, after you've waited at least ten hours, here is what I learned for you:

"In essence, a store credit card is a credit card offered by a specific retailer that you can only use with that retailer. For example, if you have a Target REDcard, you can only use the card to make purchases in a Target store or at Target.com."

As good as this course is for you in terms of financial literacy, I think you might also benefit from a course in "search skills". Ask your parents for permission to take one. Then, when you have a simple question like this, you won't have to wait.
(1 vote)
• Is it possible to find a way to Use Money in different categories?