Strategies to Pay Off Debt.

In my post From Zero to Millionaire I talked about 5 phases that you work through to go from nothing to having financial freedom. The exact order varies from person to person and the amount of time each person spends in each phase varies. The phases also overlap. But anyone that reaches financial security will pass through each one. The five phases are Make More Money, Save It, Pay Off the Debt, Invest, and Create. I talked a little about each of those, but there is a lot more. It would take books and books worth of information to truly cover each one well. Perhaps I’ll do that one day. Today I want to talk about the third one, paying off debt.

 

This post won’t be long, but it will be very specific. I’m sure you’re already well aware of the fact that debt can be dangerous. So today I’m going to talk about some of the ways to get rid of debt. These strategies are based on paying off several credit cards. The same concept works for any kind of debt.

 

Debt Snowball Method. (Most gratifying since you can see success early on.)

Step 1. Stop charging on your credit cards.

If you keep charging on your credit cards you may never pay them off. This is what the banks want, but it’s not good for your future. It’s like eating a chocolate cake after you do a pushup. Yes you exercised, but the chocolate cake offset it and more.

Step 2. Make a list of all of your debt.

Write down all of your debt and how much you owe each one. At least list all of your credit cards. I recommend including your credit cards, student loans, car loans, mortgage and anything else you owe someone. Your list might look something like the one below.

Debt Amount
Visa 1 $2,000
Visa 2 $3,000
MasterCard $5,000
Store Credit Card $1,000
Car Loan $20,000
Mortgage $100,000

 

Step 3. Sort the list by how much you owe.

Resort the list by how much you owe each account. It might look something like this.

Debt Amount
Store Credit Card $1,000
Visa 1 $2,000
Visa 2 $3,000
MasterCard $5,000
Car Loan $20,000
Mortgage $100,000

 

Step 4. How much extra can you pay?

Look at your income and expenses. If you pay the minimum balance on each card how much will you have left over. That extra money should go toward paying the principal on the cards.

Step 5. Pay them off.

Pay the minimum balance on all of your cards, put that extra money that you have to the first loan on the list. So if you have an extra $500 for the month put that money toward the Store Credit Card in this example. Once the store credit card is paid off then move on the next lowest balance. In this case the Visa card. Then you’ll have even more extra money to put towards it since you will have one less minimum payment to make.

 

By paying off the lowest balance first you will see your loans disappear faster early on. This can give you the motivation to continue.

 

Avalanche Method. (Spend the least amount of money.)

This method is similar except that you order the debt by the interest rate. Then you pay off the highest interest rate debt first. That way you spend the least money over the long run. Something like this.

Step 1. Stop charging on your credit cards.

Again, if you keep charging on your credit cards you may never pay them off. So don’t charge anymore on your cards.

Step 2. Make a list of all of your debt.

Write down all of your debt and how much you owe each one. This time add another column for the interest rate. I recommend listing everything including your credit cards, student loans, car loans, mortgage and anything else you owe someone. Your list might look something like the one below.

Debt Amount Interest
Visa 1 $2,000 18%
Visa 2 $3,000 8%
MasterCard $5,000 25%
Store Credit Card $1,000 20%
Car Loan $20,000 8%
Mortgage $100,000 5%

 

Step 3. Sort the list by how much you owe.

Now, resort the list by the interest rate starting with the highest interest rate first. It might look something like this.

Debt Amount Interest
Visa 2 $3,000 25%
MasterCard $5,000 20%
Store Credit Card $1,000 18%
Visa 1 $2,000 8%
Car Loan $20,000 8%
Mortgage $100,000 5%

 

Step 4. How much extra can you pay?

Look at your income and expenses. If you pay the minimum balance on each card how much will you have left over. That extra money should go toward paying the principal on the cards.

Step 5. Pay them off.

Pay the minimum balance on all of your cards, but that extra money that you have to the first loan on the list. So if you have an extra $500 for the month put that money toward the Visa 2 Card in this example. Once it’s paid off then move on to the MasterCard. Then you’ll have even more extra money to put towards it since you will have one less minimum payment to make.

 

This method will save you the most money because you’ll be able to pay off the highest interest rate debt first. This method is actually a little faster than the debt snowball method since you’re reducing your interest obligation faster. You’ll pay less interest so more of your payment will go towards principal. The only problem is that it may take a little longer to pay off your first one since the highest interest rate loan may not be the lowest amount loan.

 

If you’re the type of person that needs to see the early victories to keep motivated then use the snowball method. If you’re looking simply at absolute dollars then the avalanche method will save you the most money. The difference for most people won’t be huge though. The real world usually isn’t that clean. For me I used a combination. Plus I had one particular debt I hated. It wasn’t my highest or lowest amount or interest rate. But it was the one I hated have the most. I paid it off first. The true success here isn’t following one of these specific methods. The true success is paying off the debt. However works best for you is fine. List your debt however you want. Come up with a plan and pay them off. Be sure to put your extra money towards it. Paying only the minimum payment will take decades to pay off a loan.

 

What methods do you use, or plan to use? What other ideas do you have for paying off debt?

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