Debt seems inescapable, and if you are trying to make your financial future healthy it is one of the biggest obstacles towards securing a major loan, whether it be for a car or a mortgage. Frankly, banks will not feel as comfortable giving you a loan if you have a significant amount of debt. If you look, there is TONS of advice on the internet about how to make yourself debt free. They all tell you that their way is the only way. But you aren’t them. The best plan to pay down your debt is the plan you can stick to. Let’s look at two simple ways to clear that debt and their advantages:
The Debt Snowball – Say you have a Costco Credit Card with $4,000 on it (yeah, you can’t walk out of that store without spending a couple hundred bucks) at 25% interest, an $800 MasterCard balance at 18%, and a $10,000 student loan with a 5% interest rate. Rank them from least amount owed to most: 1. MasterCard 2. Costco Credit Card 3. Student Loan. Your minimum payments for them are respectively $40, $90, and $130. Now the hard part, find some extra money to put towards those debts. You can do this by picking up a couple more hours at work or move some of your fun money over to debt payment. So let’s say you scrape together an extra $40 a month. That $40 is added to your MasterCard payment and over time, while still making the minimum payments on your other debts, you pay off the MasterCard. Imagine that good feeling when that MasterCard is finally paid off! Do a little dance! Enjoy that feeling! This is the major incentive of the Debt Snowball; it gives you a sense of accomplishment early on to keep going! You then take the $80 you now have free from paying off your MasterCard and tack it on to the $90 payment of your Costco Credit Card for a total of $170, and then eventually, once that is paid off you tack that amount on to your student loan.
Debt Avalanche – This is the mathematically correct way to pay off your debt, and overall you will be saving more money! However, the downside of it is that it can take a long time to get that first win, and can leave you discouraged. In this example, you rank your payments by interest rate (1. Costco Credit Card at 25% 2. MasterCard at 18% 3. Student Loan at 5%) and you tack the extra $40 you set aside to the Costco Card first because it is your highest interest rate. You then use the same concept as the Debt Snowball!
The best way to pay off your debt is to find the way that works for you. If you’re more motivated by the mathematics behind it (clearly the most financially sound way, but I know that isn’t me) then the Debt Avalanche is the way to go. But if you like seeing results faster, using the Debt Snowball is a great way to keep you motivated.