Eliminating debt and living a debt-free life is something many people yearn for. The unfortunate truth about debt is it can be very difficult to tackle without a plan.
Each month you might be putting money towards paying down your debt, but it seems to barely move. Some months it might even feel impossible to pay it down without accidentally picking up more due to life’s circumstances.
Unfortunately, the moment you default on payments you will end up hurting your credit score significantly and we all know how this can affect your life negatively in many ways.
So, how do you tackle your debt repayment the right way?
Well, it’s pretty simple, use the two methods that have worked for millions of others.
The two debt repayment methods I am speaking of: The debt avalanchemethod and the debt snowball method.
Below I will explain the advantages and disadvantages of both debt repayment methods.
Debt Avalanche Repayment Method
With this method, you will have to create a list of all your debts starting with the debt with the highest interest rate to the one with the lowest interest rate.
For example:
- Department store credit card $5,000 at a 25% interest rate
- Capital One credit card $2,000 at 23% interest rate
- Car loan $10,000 at 5.5% interest rate
- Student loans $25,000 at 5% interest rate
- Mortgage $100,000 at 3.5% interest rate
- Doctors office $150 at 0% interest rate (pay before late fees)
You will have to consider the minimum monthly payment for each debt. Each amount will be a fixed expense that must be paid each month and should be included in your monthly budget.
Once you have established what needs to be paid, any extra income you get from your paychecks will be put towards the debt with the highest interest. This will allow you to pay off more of the high-interest principle debt, meaning that over time, you will pay less money on interest.
The biggest downside with this method is it does not take into account our emotions, stress, and ability to stick to a plan.
You need to be very disciplined and consistent in your debt repayment plan if you are using this method, otherwise, you might find yourself not paying the debts at all.
The above example is a great visual of why it’s so important to stay out of credit card debt. The interest rate on credit cards is outrageous, avoid holding a balance at all costs.
It’s best to set up an emergency fund so when life comes swinging (which it will) you have a backup plan without having to go into further debt.
Debt Snowball Repayment Method
This method was created by Dave Ramsey himself and unlike the avalanche method, you list out your debts in the order of the debt with the least outstanding balance to the one with the largest.
For example:
- Doctors office $150 at 0% interest rate (pay before late fees)
- Capital One credit card $2,000 at 23% interest rate
- Department store credit card $5,000 at a 25% interest rate
- Car loan $10,000 at 5.5% interest rate
- Student loans $25,000 at 5% interest rate
- Mortgage $100,000 at 3.5% interest rate
This method does not take into account the interest charged on the debt, the type of credit or anything else except the outstanding debt balances.
Once you have created your debt list from the smallest to the biggest, you should focus on clearing them one after the other. This means you will be able to see your progress quickly, hence the name “snowball method”.
Once your smallest debt is paid off the money you were putting towards it is then put towards your next smallest debt.
This will give you the momentum to continue clearing your debts until you become debt-free. Although it might cost you more over time, it is a proven method that works!
Personal finance is just that “personal”. When you take into account your emotions and motivation many people find this method to be much more successful.
It is, however, necessary to point out with this method, the minimum payment due to your debts is a non-negotiable fixed cost. This means you should not ignore other payments simply because you want to pay a debt that is higher on the list.
Other bills and personal expenses have to be paid along with the debt according to the list.
Which Debt Repayment Method Is The Best?
If you can be honest, watch how you spend your money and can stick to a long a term goal without seeing significant visual progress, then the Avalanche method is the ideal for you.
The Avalanche method is for those who can stick to a plan and won’t go against their goals.
However, if you are an emotional person and find it hard to stick to a plan the debt snowball is definitely your best option.
You can also mix them up and come up with a hybrid method.
For instance, you can start with the debt that has the smallest outstanding balance (Snowball) and then handle the debt with the highest interest rate (Avalanche) and later go back and handle the rest of other smallest debt payments.
In other words, you can try mixing them up. The most important thing is to figure out what works well for you and keep it simple.
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