So you’ve decided you finally want to get serious about tackling your debt, but you’re not sure how to pay off debt in a smart and efficient manner? Well first of all, congratulations on taking your first step! It’s not easy being disciplined enough each month to cut out or reduce your spending enough to pay off your debts. However, with a little bit of planning, following a strategy, and consistently implementing your strategy, you can accomplish your goal faster than you may think!
DEBT AVALANCHE METHOD
One of the most common ways to pay off your debt quickly is by using the debt avalanche method. You can easily take advantage of this method by following these steps:
1) Determine which of your loan or credit card debts have the highest interest rate. For purposes of this explanation, we’ll call this debt #1.
2) After examining your budget, decide how much additional payment per month you can afford to make. Even if it is only $10, that can make a meaningful difference in reducing the length it takes to pay off your debt.
3) Make your minimum monthly payment, plus your additional payment, until you have paid off your debt #1. During this time, you’ll of course want to keep on paying your minimum monthly payments to your other debts.
4) The following month, take the amount you were paying towards debt #1, and add that to your monthly payment for your loan or credit card debt with the next highest interest rate. We’ll call this debt #2. Remember, you will continue paying the normal amount for debt #2, but you will pay an additional amount on top of that, which was the amount you were paying towards debt #1.
5) Once you pay off debt #2, determine which of your remaining loans or credit cards has the next highest interest rate. This will be debt #3. Now, continue to pay the normal monthly payment for debt #3, but add the amount you were paying towards debt #2 for a larger payment amount.
6) Continue doing this until all of your debts have been paid off. It may seem slow in the beginning, but once you pay off 1-2 debts, the rate you are paying off the remaining debts will start to increase drastically, which is the “avalanche effect.”
DEBT SNOWBALL METHOD
Some will argue that a similar strategy is better, known as the debt snowball method. This is essentially the same thing as the avalanche method, but instead of paying off debts in the order of their interest rates, you pay off debts with the lowest balances first. Here’s a quick outline of the steps to follow for the snowball method:
1) Make a list of your consumer debts. This would include personal loans, auto loans, medical bills, credit cards, student loans, etc – but not your mortgage loan because that’s a whole different animal. You don’t need to worry about the interest rate here, just take note of the balances due for each debt. The debt with the smallest balance will be debt #1.
2) Consider how much extra cash you can apply towards paying off your debts, in addition to your minimum monthly payments. Remember, even just $10 can go a long way in helping you pay off your debts faster!
3) Make your minimum monthly payment, plus your additional payment, to debt #1 each month until it has been paid off. Continue paying the minimum monthly payments on your other debts while doing this.
4) The following month, take the amount you were paying towards debt #1, and pay that towards your debt #2. This will be the remaining debt with the smallest balance. Once again, the amount you will pay towards debt #2 will be the normal minimum monthly payment for debt #2, plus the amount you were just paying towards debt #1.
5) Once you pay off debt #2, determine which of your remaining loans or credit cards has the smallest balance. This will be debt #3. Continue to pay the normal monthly payment for debt #3, but add the amount you were paying towards debt #2 for a larger payment amount. You get the idea.
6) Keep following this routine until you have paid off all of your debts. As mentioned in the previous method, it may seem very slow in the beginning. However, once you’ve paid off 1-2 debts, the rate at which your debts are being paid off will start to increase significantly. This is the “snowball effect.”
Because there is an element of psychology to managing money and debt reduction, there isn’t a “better” strategy that applies to everyone. Consider which method resonates with you the most, and then follow that strategy. Some people are motivated by seeing faster results. If this is the case, the snowball method may work better for you because you’ll be able to pay off the smaller debts faster and can start to see the snowball effect work faster. You may end up paying more in interest, but ultimately, if it helps you succeed in paying off your debts, it’s a winner winner chicken dinner!
SMART FINANCIAL TIP
Once you have finished paying off the final debt, take the amount you were paying each month and continue paying that into your savings account. You could even determine an amount you would like to have sitting in savings, say $3,000, and consider that another debt. Even though it is not actually a debt, you could “pretend” that it is, and keep putting money towards your savings goal until you have saved that amount.
SPECIAL CONSIDERATION – How To Get Out Of Debt
If it seems like the amount of debts you have are just too overwhelming, from a psychological point, it may be helpful to get a consolidation loan for some of your debt in order to reduce the number of debt payments you will be making. This could also help if it coincides with needing some help paying bills to get you in a better position to start a debt reduction plan. A good option may be to apply for a short-term loan online, because you can apply in less than 2 minutes, the approval rates are very high, and you can get the money as soon as the next business day. It also may be a good idea if some of your debts have a very high interest rate. Consolidating those debts to a single loan with potentially a lower interest rate could help save you some money while you are implementing one of the above debt reduction strategies.
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Mike Lombardi, MBA
Personal Finance Expert
Mike Lombardi earned his bachelor’s degree in Finance, as well as his MBA in Economics. He has been in the personal finance industry for 24 years. He spent 12 years working for a large bank as the loan operations manager before switching gears and managing client portfolios at a small wealth management firm. He enjoys helping people develop and implement a personal budget, formulate a strategy to improve their credit scores, and show them how to work towards becoming debt free by designing a debt reduction plan unique to each person’s situation.