Question

Obligation Debt Amount Min Monthly Amount Annual Interest Rate Student loans $40,000.00 $500.00 6.00% Car loan $11,500.00 $375.00 9.50% Chase credit card $2,100.00 $84.00 18.00% Amazon credit card $1,050.00 $42.00 15.00% TJ Maxx credit card $380.00 $15.00 24.00% You recently graduated with a reasonably well paying job and after reviewing your budget you have an extra $200 a month to put towards paying off your debts as you have built up an appropriate savings. In exactly 12 months, you have been promised a raise that will allow you to put a total of $400 a month towards paying down debts (original $200 plus another $200). How many months will it take to pay off the chase card if you pay the minimum monthly amount listed above on the Chase card? Hint: the first month the interest rate is 18%/12 = 1.5%. The interest owed is 1.5% of $2,100 = $31.50. So you will pay down your debt by $42-$31.50 = $10.50. This means you owe $2,100 - $10.50 = $2,089.50 the next month. (Use a spreadsheet!!). Your answer is between 90 and 100 months!! Use this technique later down below.Discuss two approaches a) paying the highest interest rate debts first or b) paying of the smallest first. Which is theoretically best and which is emotionally best for people. Do appropriate research and reference.

Answer 1

Loan amount due, PV = $ 2,100

Interest rate per month, Rate = 18% / 12 = 1.5%

Min amount = PMT = 42

Period can be calculated using the NPER function of excel.

Period = NPER (Rate, PMT, PV, FV) = NPER (1.5%, 42, 2100, 0) =  93.11 months

It will take 93.11 months to pay off the chase card if you pay the minimum monthly amount listed above on the Chase card.

Discuss two approaches a) paying the highest interest rate debts first or b) paying of the smallest first. Which is theoretically best and which is emotionally best for people.

Theoretically and mathematically, if the funds available are limited, the higher cost of debt should be retired first followed by the lower cost of debt. A delay in retiring higher cost debt, will lead to accumulation of interest at a faster rate. If one decides to delay the repayment of higher cost debt, the accumulated interest will lead to tremendous pressure.

Emotionally, people do think that one should retire the lower cost debt first and then move to the higher cost debt. This is because you can retire a low cost debt relatively faster and then you can focus on the higher cost debt.