Paying down a debt? Think of the interest rates as returns.

September 3rd, 2012 by FB @ FabulouslyBroke.com

I know it sounds stupid, but it might help to think of the interest rates on your debt as returns on your money.

Let’s say you have 2 credit cards:

One card with a $5,000 balance at 9% interest

The other with a $10,000 balance at 12.5% interest

If you look at the balances, it might make more sense to pay the smallest balance first — $5000 — right?

What if you thought of those interest rates as “rates of return”? I know that isn’t technically true, because it’s a cost and a debt to you, but by seeing them as ‘rates of return’, it might make more sense.

Think of it this way:

You have $500/month to put towards debt.

Wouldn’t you rather get back 12.5% than 9%?

You could definitely clear that $5000 debt sooner and just have one card to focus on.

Psychologically speaking, this is very rewarding for many people.

However, when you consider the rationality of it all, the best return will always be to make your money go farther by paying down the one that is costing you the most in interest — the 12.5%.

You’d be “making” 3.5% more than if you paid that money towards your 9% debt.

So think about your interest rates as rates of return, if you are paying down your debt and starting to feel fatigued.

It might help give you a renewed motivation to do better.

What do you think?

If you had/have debt, did/do you ever think of your debt in this way?

I know I didn’t…!

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  • http://thehumbleminimalist.blogspot.com/ marie

    Hey, great idea!
    Although, if I may point out, in this instance the numbers are pretty straightforward, but people might get confused by the interest rate here, because they might think you have to pay off the credit card with the highest interest rate first, but what if you owe 12.5 on 5k and 9% on 10K, then which is better to clear first? Most likely the 10K anyway in spite of the interest rate (converted to actual numbers, you loose less percentage, but more actual money). Maybe you can explain a bit more with numbers and stuff for people who don’t usually think of it that way? But it’s a really good way to save money and pay off your debt too! :D