5/21/2014 2:45 PM ET|
What's the best debt payoff strategy for you?
Making sure you have a solid payoff strategy is the first step toward climbing out of debt.
You know the old saying “failing to plan is planning to fail”? That doesn’t just apply to college tests and job applications. It also applies to paying off debt.
So before you start throwing money at your debt haphazardly, see which of these three debt payoff methods will work best for you.
The debt snowball
With the debt snowball method, you pay off your debts in order from smallest balance to largest balance, regardless of interest rate or monthly payment.
So you pay the minimum balance on all other debts, but pay whatever extra you can on the smallest debt to get it paid off faster. Then, each time you pay off a debt, you add the payment you were making on it to the monthly payment for the next debt you pay off. Each time you pay off a debt, you’re throwing even more money at the next debt down the line. By the time you get to your largest debt, you’re making very large monthly payments.
The perks: This method is very emotionally rewarding. When you can pay off two or three of your smallest debts very quickly, you’ll get a burst of energy to keep going. And by the time you start slogging through your biggest-balance debt, you’ll have plenty of ammunition to throw at it.
The drawbacks: Since you aren’t taking interest rate into account, this method can cost you a lot more in interest over time.
Who’s it for? If you really need a kick in the pants to stick with paying down debt, this method is for you. Paying off those first small debts can really make a difference in your long-term perseverance. And if you don’t have any super-high-interest debts, you won’t spend that much more in interest over the long term.
The debt avalanche
With this method, you pay off your debts from largest interest rate to smallest interest rate. Pay whatever extra you can on the debt with the highest interest rate, while making the minimum payments on your other debts. When you pay off one debt, you add that payment to the next debt with the next highest interest rate, and so on.
The perks: Especially if you have high interest rate debts, this method could potentially save you thousands of dollars over the long term. Getting rid of those high interest debts early can really make a difference.
The drawbacks: If your highest interest debt also has a large balance, you may get discouraged at how long it takes to get going.
Who’s it for? If you know you can stick with paying down your debt, regardless of how long it takes, this is the most scientific, money-saving method to use. And it’s especially important to consider this method if you’re dealing with very high-interest debt.
The biggest impact
When you have one or two debts with very high monthly payments, you may want to pay them off first. This is especially true if you’re on a variable income, and sometimes barely squeak by when making minimum payments.
Sometimes with this method you’re not actually paying down a debt; you’re getting rid of it. For instance, if you have a $500 car payment, downgrading your car could seriously lower that payment without going through the work of actually paying it off month by month.
The perks: Getting rid of one or two high payments can even out your budget. Plus, offloading that $500 car payment gives you a lot more money to throw at your other debts.
The drawbacks: You may need to actually sell an item to get out of these high payment debts. And if you’re not taking interest rate into account, you’ll probably wind up paying more interest this way.
Who’s it for? If you need to get out from under one particular high payment, consider just selling that item to offload the debt. That starts out your debt payoff with a huge monthly impact. Then you can pay off the rest of your debts using one of the other two methods.
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