Polls / May 4, 2012

If repaying several debts, do you pay the smallest loan off first or the one with the highest interest rate?

If repaying several debts, 58% of respondents to the latest eZonomics online poll would pay the loan with the highest rate first.

Interest costs
Say you had a mortgage, a bank loan, money borrowed from your family and a credit card balance to pay off. Juggling several debts can be a challenge. Paying off the most expensive loan – the one with the highest interest rate – quickest is typically a good method to avoid wracking up extra interest charges. It might mean meeting payments on the mortgage (a long-term house loan that usually has a relatively low interest rate) and ploughing spare cash into cutting credit card debt (designed for short-term borrowing and usually with a relatively high interest rate).

I want to see progress
But the financially sensible option and what people actually do are sometimes different.
An experiment testing the psychology of debt management found participants “consistently paid off small debts first, even though the larger debts had higher interest rates”. Our tendency to break complicated tasks into more manageable parts was part of the reason given for this seemingly strange behaviour. The authors – which included Predictably Irrational author Dan Ariely – theorised that people would pay off the smallest loan first to reduce the total number of outstanding loans and get a sense of “tangible progress” toward paying off their debts.

DebtMental accountingDan ariely

eZonomics team
.(JavaScript must be enabled to view this email address)