There are many ways that you can pay off your debt. The trick is finding out which one will work best for you. Believe it or not choosing the right method may come down to your personality rather than external factors such as saving on interest.
Some of us may need encouragement along the way in order to become debt free once and for all. While others of us would much rather save on interest and time.
Or maybe you want to leave the details to someone else while you just make the specified payments. Either way there is an option out there for each of us.
Here are the methods to pay off debt:
Choosing Between the Methods
Debt Payoff Method | For People Who... |
|---|---|
The Snowball Method | need encouragement and motivation along the way |
The Avalanche Method | want to pay less in interest |
The Balanced Method | want to put extra towards more than one debt |
Debt Consolidation | want to make just one payment for all debt |
Debt Management Plan | can't afford their current payments due to limited income |
Now most of you may have heard of the first two methods but not so much of the last one. That’s because it is something I inadvertently did when I finally became debt free a few years ago.
If the first two methods don’t do it for you, this one might strike the perfect balance.
We’ll also get into some other techniques, such as debt consolidation and debt management plans, for those who like to keep their options open.
The Snowball Method
The debt snowball is a method in which you pay off debt starting with the smallest. You first make a list of all of your loans and credit card debt. Make sure you include the debt, the amount of the debt, and the interest rate (APR).
Then you are going to order your list by the amount of debt with the smallest amount being first. This will be the order in which you will pay them off: starting with the smallest.
The Process
So you will pay the minimum payment on all of your debts, but any extra money that you can scrape up or that you have specifically budgeted for your debt will be put towards the debt with the smallest amount. You will continue to do this each month until the debt is paid off.
The Snowball Method can keep you engaged in paying off your debt with "quick wins".
Once that debt is paid off, everything that you had been paying towards that debt you will take and put towards the second debt on the list. With all the extra payments going to this debt it will be paid off much faster.
This is the snowball effect, the more debt you pay off, the faster it becomes to pay off the remaining debt.
The snowball method is a go-to fave of Dave Ramsey. It is for people who are easily de-motivated and need the encouragement (or "quick wins" as Dave Ramsey puts it).
The Snowball Method Order
The Type of Debt | Payoff Order | Amount | Interest Rate (APR) |
|---|---|---|---|
Credit Card #1 | 1st | $5,000 | 14% |
Car Loan | 2nd | $12,000 | 6% |
Credit Card #2 | 3rd | $17,000 | 17% |
Student Loan | 4th | $30,000 | 5% |
*Mortgages are not included in the table as these tend to be very low interest (< 4%) and it may be more beneficial to use the money to invest rather than pay off your mortgage.
Shorter Loan Terms often mean lower interest rates but higher monthly payments.
The Avalanche Method
Unlike the snowball method which required you to pay off the smallest debt first, the avalanche method requires you to pay off the debt with the highest interest rate first.
So after writing all your debts down, you would then order them by interest rate starting with the highest. And as you pay off the debt, you’d work your way down paying all that extra freed up cash to paying off the next debt and so on just like in the snowball method.
The benefit of this method is that by paying the debt with the highest interest rate first you will save the most money in interest. Furthermore, you may also be able to pay off your debt faster as the largest hole in your pocket gets plugged first.
This allows all that extra cash (that you are not paying in interest) to be put towards the other debts that aren’t costing you as much.
The Avalanche Method gives you the best return on your money.
The debt avalanche method is for the people who want to save money and time and who have the discipline to follow through.
Like the snowball that picks up speed as it goes, the avalanche may take time to build up ‘speed’ but once it gets going, its unstoppable.
The Avalanche Method Order
The Type of Debt | Payoff Order | Interest Rate (APR) | Amount |
|---|---|---|---|
Credit Card #2 | 1st | 17% | $17,000 |
Credit Card #1 | 2nd | 14% | $5,000 |
Car Loan | 3rd | 6% | $12,000 |
Student Loan | 4th | 5% | $30,000 |
The Balanced Method
The balanced method can be used if you want to pay extra on more than one debt at a time. To pay off the debt faster you may want to limit it to just two. This method involves paying on the debt proportionally.
I inadvertently did something like this while I was trying to pay off my debt a few years back.
Story Time
They say when you know better, you do better. Well, actually a few years ago when I was paying off my credit card debt and a car loan (always a terrible idea…the car loan I mean), I made the mistake of paying more towards the car loan, which not only had the lowest interest rate but also was the bigger of the two.
An epic fail as far as the avalanche and snowball method are concerned.
I did this solely because when I looked at the statements, I saw that the car loan was costing me more than $20 a month in interest. Meanwhile, my credit card was charging a little under $10.
So I concluded that the loan was the problem and threw most of my extra money at it.
Little did I know at the time that if I really wanted to save money, I should have paid off the credit card first, as its APR was much higher. Luckily, I did throw extra money at the credit card debt as well. But I did so proportionately with most of my money going towards the loan.
How it works:
The balanced method is essentially paying off debt proportionally. Say, for instance, you have a total debt of $15,000 with your student loan debt account for $10,000 and your credit card debt account for $5,000.
Proportionally, your student loan debt takes up 2/3 of your total debt and your credit card takes up 1/3.
Therefore, when you go to pay your bills each month, you will make proportional payments. If you have $1,200 for paying off your debt you would take $800 and put it towards the student loans and the remaining $400 towards the credit card debt.
With this method you could do mix and match with the snowball method and the avalanche method. So you could focus on putting the extra money towards both the smallest debt and the one with the highest interest debt.
You could pay more towards the debt with the highest interest but still pay extra on the smallest debt. Or you could to it the other way around. Then once those are paid off you can put the extra money towards the remaining debt. Feel free to change it up and do what works for you.
The Balanced Method gives you a way to do a little of both the Avalanche and Snowball method.
Debt Consolidation
You may wish to go the route of consolidating your debt with a personal loan or by using a balance transfer offer. By doing this, you can take advantage of a much lower interest rate.
Though these options may be tempting, I think for most people it is not the best choice as it only provides a temporary solution and requires you to open up new debt accounts.
Balance Transfers
Doing a balance transfer and getting a personal loan both come with fees imposed up front by the banking institution. Be sure to check how much these fees are going to cost you and whether paying them is worth it.
With balance transfers, there is also a very short time limit on this discounted or 0% interest rate. So if you cannot pay off the balance in that time, this method could end up costing you a lot more in the long run.
Personal Loan
Similarly, when you take out a personal loan to consolidate your debt, you can save money on interest due to lower rates. However, these loans tend to have a longer time frame and may be better for your credit than opening up a new credit card.
Consolidating your debt does not mean that now your credit cards are free to use again. So when going this route, be sure to put in place some safeguards so that you do not get into more debt while you are paying off your original debt and that you do not go back into debt after it is paid off.
Debt Consolidation may save you on interest but beware of the fees.
Debt Management Plans
If you are really without all hope and the payments are just too high for your income, you may need to seek professional help. There are debt management companies who will negotiate with the credit card companies for you.
They will help lower your payments, your interest, and maybe even help get the late fees waived. This is only offered for credit card debt and debt from medical bills though. Home and car loans are not covered.
Signing up for a debt management plan will cost you money, in the form of monthly fees that you pay to the company. But it can be worth it for the stress relief of lower payments and someone else handling all the negotiations for you.
This route, I believe, should be reserved as a last resort. It is for people who just simply cannot stay afloat with their current debt load. When you use debt relief services credit card companies may close your accounts, which would negatively affect your credit.
Even if they do not, you may not be allowed to use your credit card at all for risk of no longer qualifying for the program. Check your agreement carefully before signing up.
Be careful to choose a good company though as I have heard that some are nothing more than scams.
All in All
While you can choose from any of the methods above, choose the one that is better suited for you, your personality, and your financial situation.
While the avalanche method puts your money to work most efficiently by saving you the most in interest and time, the snowball method gives you constant encouragement and helps you stay motivated.
If you are easily discouraged, the snowball method might be the best option for you. If you wanna save money and time, the avalanche method, is your man. And if you want to do a little of both, go for the balanced method.
Either way, the key to paying off any debt is consistency. As long as you are consistently paying it down, you will eventually pay it off. So just choose one and get to it. You can always change your mind later.
APR and interest rate tends to be used interchangeably but they are actually a little different. The APR is the interest rate plus fees. Whenever I say interest rate, I mean APR.
Bonus: Did you know there's a way to become debt free without a budget?
*DISCLAIMER: The Information provided in this post is simply the opinions of the blogger and is given in the spirit of educational fun. It is not investment advice. Please do your own research and decide what is right for you before investing in any asset. If necessary, seek the help of a certified professional in discussing your options.