If you’re currently struggling with debt, the good news is you can take advantage of the experiences and successes of the countless people that have worked their way out of debt. By following a structured process to first eliminate your debt, and then making adjustments to your money management techniques you can quickly be on your way to financial freedom and squeezing every drop of possible enjoyment out of your life.
There are several proven methods to attack and eliminate debt, each having advantages and disadvantages. To successfully eliminate debt, a person’s specific situation needs to be evaluated to determine the best method to use.
In the Debt Snowball method, debts are listed in order of the size of the balance. Focus is put on the account with the smallest balance, with all extra funds being funneled towards paying it off as fast as possible. Only the minimum payment will be made on all other accounts. Once the first account is paid in full, the funds that had been going towards that account each month are then applied to the next smallest account. As accounts are paid off, the amount being applied to the next account on the list becomes larger and larger.
To see how the Debt Snowball method helps eliminate debt, take the following example debt scenario:
Credit Card 1:
Interest Rate: 13%
Minimum Payment: $25
Credit Card 2:
Interest Rate: 15%
Minimum Payment: $20
Credit Card 3:
Interest Rate: 19%
Minimum Payment $25
If the debt snowball method was used, paying off credit card #2 would be the first priority as it has the lowest balance. Once it was paid in full, the focus would shift to credit card #3, and then finally credit card #1.
By using a debt snowball calculator found online, if a person is able to apply an extra $150 towards debt each month in addition to the $70 already required for minimum payments, the debt would be gone in 11 payments, with about $168 being paid in interest.
The debt snowball method has a significant psychological benefit. Accounts are paid off quickly in the beginning, providing satisfaction of reducing the number of active accounts and giving a very real sense of significant progress. As the debt snowball progresses, the feeling of progress also grows as the payment rolled over to the next account grows and the process gains momentum.
Another advantage of the snowball method is logistical. As low balance accounts are paid off quickly, it reduces the number of overall accounts to keep track of. This lowers the time and effort needed to manage a person’s finance.
People who would benefit and be motivated by the relatively quick elimination of the first few accounts should consider choosing this method.
The debt avalanche method is similar to the snowball method in that focus is given to one account at a time. However, with debt avalanche the order in which accounts are paid off is based on their interest rate. The account with the highest interest rate is paid off first. Once it its paid in full, it’s payment amount is then added to the monthly payment of the account of the next highest interest rate.
Using our same debt example of three credit cards totaling $2100 in debt, the order in which the accounts are paid off is slightly different. The focus would start with credit card #3 since it’s interest rate is the highest, then shift to #2, and finally credit card #1.
Using the debt avalanche method, and applying the same extra $150 towards debt elimination, 11 months would still be needed to pay off the debt, but only $144 would be paid in interest.
The advantage of this method is efficiency. By paying off the accounts with the highest interest rate first, interest payments will be minimized saving a person money and paying off the debts with maximum efficiency.
This method is a good choice for disciplined people who are most interested in eliminating debt as quickly as possible with the least amount of money possible out of their pocket.
A debt consolidation loan can be used to fold multiple debts into a single account. The borrower uses the funds from the loan to pay off lines of credit. A single payment is made each month towards the consolidation loan, and in many cases the interest rate is lower than that of typical unsecured lines of credit.
This method of debt repayment greatly simplifies a person’s finances, and also can lower the total monthly payment as the term of the loan is usually 3-5 years. The downside of a debt consolidation loan is that it may result in larger total interest payments due to the length of the term, as well as the length in time the borrower will make payments.
Using our debt example once more, the person with debt may decide to eliminate their debt with a consolidation loan with a term of 3 years (36 months) and an interest rate of 10%. Using this method, the payment would be $68 a month, but would take over three times as long to pay off the debt. The amount of interest paid would also grow substantially to $348.
This method is a great choice for people who are having problems meeting their monthly financial obligations and need a forced monthly payment with a fixed term to help them eliminate their debt.
Build An Effective Personal Finance System
Regardless of what method is used, eliminating debt is only part of the process. If the reason for accumulating debt to begin with is not addressed, credit balances will return. Funds that could have been used to build wealth will again have to be used to eliminate debt.
Below are some actions that can be incorporated into a person’s personal finance management system to help minimize spending waste, and maximize the funds available to either eliminate current debt or to funnel into wealth building funds.
Evaluate Monthly Expenses
Evaluate every monthly expenses for value. Reduce or eliminate expenses that are not being used or are not being fully utilized.
Behavior not tracked cannot be changed. Having a comprehensive list of how one’s money is spent can provide insight into what behaviors could be changed to reduce wasteful spending.
Finding a side hustle can help greatly improve your financial health. Working just a few extra hours a week can greatly help improve a person’s financial health.
Failure is imminent unless a person has a plan for their money. A budget provides a blueprint for how a limited amount of funds will be used.
Where To Go Next
There is a wealth of information on the internet that can help a person looking to get out of debt. To do some analysis of how the three debt elimination methods mentioned here apply to your specific situation, check out these calculators:
Click here for more information on mastering the debt snowball method.
Check out this blog for more analysis of the debt avalanche method.
If you need help getting started with a budget, You Need A Budget is a fantastic tool that will help you get your finances in order.
The above information gives people looking to eliminate their debt the tools to best choose the right way to do so, as well as address the spending behaviors that led to it in the first place. Funds that had been used to make debt payments can then be used instead to build wealth and work towards the goal of financial freedom and ultimately a more fulfilling and enjoyable life!