How To Pay Off Your Debt For Good

personal finance Sep 28, 2020
How To Pay Off Your Debt For Good by TTM Education

The average credit card has a balance of $6,354 and the average consumer has 4 credit cards. That’s $25,400 in credit card debt – not a small amount to get out of, so what do you do?

Budgeting your way out of credit card debt takes consistency, patience, and plenty of dedication, but it’s not as hard as you might think. There are two main ways to pay off credit card debt – the debt snowball and debt avalanche method.

One isn’t better than the other,  it’s a matter of personal preference.

What is the Debt Snowball Method?

The debt snowball method focuses on your account balances rather than the interest rate or monthly payment.

You pay the debts off in order of balance, smallest to largest. The idea is that you have ‘small and quick wins’ by paying off the smallest credit card first. When you pay off that first card and see success, you should carry that motivation onto the next debt in line until you eventually pay off all of your debt.

How to Use the Debt Snowball Method

Here’s a quick example of how it works.

John has four credit cards, a medical debt, and a car payment. He orders the debt by balance size as follows:

  • Credit card 1: Balance $1,000, Payment: $25 and APR 12%
  • Medical debt: Balance $1,500 Payment: $40 
  • Credit card 2: Balance $2,200 Payment $50 and APR 5%
  • Credit card 3: Balance $3,700 Payment $65 and APR 20%
  • Credit Card 4: Balance $5,000 Payment $75 and APR 10%
  • Car payment: Balance $14,000 Payment $200 and APR 5%

First, John sets up his budgeting so that he makes the minimum payment for each debt monthly. He also determines how much extra money he has each month. After looking at all of his bills, he realizes he has $300 extra each month.

John applies the extra $300 to credit card 1. This is in addition to the $25 minimum payment, so he pays $325 to that card and the minimum payments to each of the other cards.

In just four months, John pays off the first debt. He then takes the $325 and adds it to the minimum $40 payment for the medical debt, paying $365 a month until that debt is paid off in full, which takes 5 months. 

Next, John pays $365 plus $50 to credit card 2 until it’s paid off. He keeps going down the line like this until his debt is paid off in full.

What is the Debt Avalanche Method?

The debt avalanche method focuses on APR (Annual Percentage Rate) rather than balance. What is APR ? It's essentially the annual cost you pay or the price you pay to borrow money, expressed as a percentage. This percentage includes costs such as your interest rates and all other fees you may be required to pay to take a loan. This method decreases the total interest you pay by paying off the debt with the highest APR first. You won’t see fast progress, but once you get going, the savings really add up.

The debt avalanche method puts your debts in order of APR, highest to lowest. It doesn’t consider the balance or minimum payment  like the debt snowball method, it requires you to make minimum payments on all debts except the first in line.

How Does the Debt Avalanche Method Work?

Using the same example from above, let’s see how the debt avalanche method works:

  • Credit card 3: Balance $3,700 Payment $65 and APR 20%
  • Credit card 1: Balance $1,000, Payment: $25 and APR 12%
  • Credit Card 4: Balance $5,000 Payment $75 and APR 10%
  • Credit card 2: Balance $2,200 Payment $50 and APR 5%
  • Car payment: Balance $14,000 Payment $200 and APR 5%
  • Medical debt: Balance $1,500 Payment: $40 

John makes the minimum payments as described above. With his extra $300, he pays credit card 3 down first. It takes John 12 months to pay off credit card 3 in full. He then takes the $365 he paid toward credit card 3 and pays it toward credit card 1. It only takes 3 months to pay off credit card 1, so John then takes the $390 he paid toward credit card 1 and adds it to the minimum payment for credit card 4 to keep the debt avalanche going.

Which is Better – Debt Avalanche or Debt Snowball?

One method isn’t better than the other. It depends on your cash flow and your preferences. If you struggle to stay consistent paying your debts off, use the debt snowball method, and let the quick wins motivate you.

If you’re focused on saving more money on interest and putting more money in your pocket, choose the debt avalanche method. Just make sure you know the debt avalanche method requires patience and dedication.

You won’t see quick wins for the first few months at least, in fact, you won’t see much progress. But stay consistent and keep going. You’ll get to the point that you see the light at the end of the tunnel – you’ll pay your first debt off faster than you thought possible and save yourself thousands of dollars in interest.

Some people start with the debt snowball so they get used to consistently paying debts off and then switch to the debt avalanche to save even more money on interest.

Choose the Debt Payoff Method that’s Right for You

No one can tell you which method is right – you have to figure out which method you’ll stick with the best. Remember, this is a work in progress – you didn’t get into debt overnight and it won’t go away overnight.

With consistent effort, constant budgeting, and a careful eye on your cash flow, you’ll dig your way out of debt and live financially free. 

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