Let’s be blunt if you have debt you need to pay it off as fast as possible!
A little debt, a lot of debt. It doesn’t matter, pay it off!. Maybe your debt’s even gotten to the stage that it has become crippling. There is a way out for everyone with debt. All you need to do is put together a debt elimination plan.
And stick to it!
The personal finance crown generally has two debt elimination plans, one is called the debt snowball, and the other the debt avalanche. It’s doesn’t really matter which one you choose to use in your debt elimination plan. You just need to stick to one and pay above the minimum debt payments.
These two methods are well-known in the personal finance crown, but if you are outside this network they may be new to you. I know that I didn’t know about them before I started to get serious with learning personal finance. Either way, if you know them or not, there is one thing that you do need to do.
You need to treat your debt as an emergency
Basically, debt is the opposite of investing. You will never become financially independent if you carry debt.
The longer you hold debt, the more it cost you. Same goes with investing, the longer you invest, the more you will earn. Debt and investing are opposite sides of the same coin. They both use the powers of compound interest.
One is working for you, and the other is working against you. You need to get rid of things that are not working for you. And then focus on getting things that work for you. And as fast as you can. So how do you do it?
The Debt Snowball Method
The debt snowball method is a metaphor for how a snowball is formed. You start off with a tiny piece of snow. Then this grows to a medium-sized ball, then to a large ball, and then the ball is so big that it rolls by itself, down the hill and out of your life.
So with the debt snowball method, you want to focus on paying off the smallest debts first. (the smallest in terms of dollar amount) Once you have paid the smallest debt off, you move to the mediums debts, and then the larger debts. And so on. Starting with the smallest and working your way up to the largest.
The one thing you have to remember is that you need to keep paying the minimum amount on all your debts. Otherwise, you can get stung by different late payment fees. When you are focusing on paying the smallest debt off, you direct any extra money you have towards it.
Once you have paid off the smallest debt, you then direct the payments that were going to this debt to the medium-sized debt. This will make paying off the medium debt faster, as you have now directed the money that was paying the smaller debt towards the medium debt.
And then once that debt is gone, you shift all the money to the next debt.
So the snowball metaphor also refers to the size of the payment towards the debt you are focusing on. Each time you have paid off a debt, you’re payments towards the next debt have snowballed together to become larger.
The reason that the snowball method is useful for people is that it is rewarding. It keeps you motivated early on. Paying off the smaller debt is generally faster than the larger ones. Once you have paid off the smallest debt you will feel good about it. One of your debts is gone. This feels empowering.
You will see progress quickly and start to feel like you can really get rid of all of them. It keeps you motivated to get rid of them all!
The Debt Avalanche Method
The debt avalanche method is another type of accelerated debt payoff. You will still pay off each debt by the minimum payment, and then devote any extra money you have to pay off the debt with the highest interest rate.
Once you have paid off this debt, then you focus on the next debt with the highest interest. And you continue until all the debts are paid off. Starting with the highest interest rate, and moving through until you have paid the lowest interest rate debt. At which point you are debt-free.
This method can result in fewer rewards in the beginning, as your highest interest rate debt could be your largest- so it will take longer to pay off. But mathematically, it is more beneficial to pay off the debt with the highest interest rate.
By reducing the debt with the largest interest rate first, you will lower the cost of interest on your debts. As with any debt payment plan, it will take discipline and commitment to pull off.
The problem most people have is to fall back into paying the minimum payment. Which will give your debt more time to compound in size.
Do Methods Matter?
In reality, both methods are very similar. Both emphasize that you should pay the minimum on all debts and focus on one. You can choose to use a combination of both methods. Doesn’t matter. As long as you are paying more than the minimum towards your debts they will eventually be paid off.
I would argue that you need to concentrate every extra dollar you have towards your debts so that you can start to focus on getting ahead. Having debt will just hold you back from getting ahead.
Example
Let’s just say for examples you have three debts. A Car loan, credit card debt, and a higher purchase debt from an appliance store.
- A car loan from you Bank: $7000 (8.9%), 5-year term, $145 per month
- Credit from a home appliance store: $1800 (14.99%), 3-year term, $62 per month
- Credit Card Debt: $2950 (20.95%), payment of $150 per month
If you were to use the snowball method, you would focus on paying off the appliance debt $1800, then the credit card debt of $2950, and finally the car loan.
If you were to use the avalanche method, you would pay the credit card first, then move onto the appliance debt, and finally the car loan.
If you do nothing but pay the minimum you would be shelling out an extra $4000 for the car, and an extra $1000 of the appliances, and an extra $1500 on the credit card. In total, you would have borrowed $11,750 and it would have cost you $18,250
Over the 5 years, these debts would have cost you $6500 in interest.
In Summary
Debt is an emergency, and you need to get rid of as soon as possible. Don’t be ashamed that you have debt. Today’s culture exposes and normalises debt for everyone. You can’t watch TV without being bombarded with deals of debt. Heck, many companies actually sell debt rather than products. Car dealers and electronic stores make money on selling you finance, rather than actual products.
If you are struggling with debt I really encourage you to check out Sorted debt calculator. Their calculator includes interest-free periods, and you can work out how long it will take to clear all your debts.
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