Financial problems are all around us. Many Americans today are in debt and are having difficulty paying it down. According to the latest statistics:
- U.S. households have more than $15,000 in credit card debt.
- 43 percent of Americans spend more than they earn.
- 14 percent of income is used to just pay interest on credit card debt.
- Overall, consumer debt has increased by more than 1,700 percent since 1971!
In addition, financial problems is the No. 1 stressor in marriages and is cited in 90 percent of divorce cases. If you are one of these statistics, don’t despair. Following these steps can help you get out of debt sooner than you think.
- First, you must stop making excuses about your debt and start tackling it right away.
- Second, start a budget to control your expenses. Start with your income, and then begin subtracting your expenses, then set up your budget to control those expenses.
- The crucial thing here is to distinguish between your needs and wants, and then cut back on the unnecessary wants. In your budget devote more money to paying down your debt than just the minimum.
- The next step is to start paying down your debt! There are two popular ways to pay down debt: The Debt-Snowball Method and the High Interest Method.
The Debt-Snowball Method
This method focuses on paying down the smallest debt first regardless of the interest rate. You concentrate on paying down as much of the smallest debt first while making the minimum payments on the rest.
When you finish paying off the first debt, you roll over that payment to the next debt payment in addition to the minimum payment you were already making. When you continue to do this, the payments you make toward your debt grows larger like a “snowball.”
To get started, first list all of the debts you have from smallest to largest. The interest rates and minimum payment amounts don’t matter. Here’s an example:
1. | Credit Card #1 | $500 | 15% Interest Rate | Minimum payment $50 |
2. | Credit Card #2 | $800 | 18% Interest Rate | Minimum payment $80 |
3. | Car Loan | $5,000 | 10% Interest Rate | Monthly payment $150 |
4. | Student Loan | $10,000 | 5% Interest Rate | Monthly payment $100 |
If you are making the minimum payments on all of these your total is $380 dollars. Let’s say you are able to throw an extra $250 to pay off your debt every month. You will apply that amount to debt #1 ($300 = $50 + $250). This means in month two debt #1 is paid off.
In month three you want to take the $300 that you were paying to debt #1 and apply it to debt #2. So that means while you are making minimum payments on the other debt, for debt #2 you are now paying a total of $380 ($300 plus the $80 minimum you were paying already).
You repeat this every time you pay down a debt, hence the payment amount snowballs and the payments get larger.After debt #2 is paid off, you add that payment to debt #3 which is now $530 ($300 from debt #1 + $80 from debt #2 + $150 minimum payment for debt #3). This leaves $630 for your last monthly debt payment!
Here is how the debt snowball looks like:
$300 (Debt #1)
$380 (Debt #2)
$530 (Debt #3)
$630 (Debt #4)
The reason this method can be effective is that uses human psychology to your advantage. By paying of the smaller debts first, you see fewer debts and get small positive victories. This is in turn motivates you to continue going to pay down your debt. The key here is to NOT continue adding more debts!
The High-Interest / Avalanche Method
In the long-run you may pay more money using the Snowball Method than the than the High-Interest Method, also known as the Avalanche Method since higher interest debt can compound over time, increasing your debt amount.
Like the Debt Snowball Method, you will list all of your debts. Instead of doing it order of debt amount, you want to do it in order of highest interest rate to lowest rate. Using the example above here is how it would like look.
1. | Credit Card #2 | $800 | 18% Interest Rate | Minimum payment $80 |
2. | Credit Card #1 | $500 | 15% Interest Rate | Minimum payment $50 |
3. | Car Loan | $5,000 | 10% Interest Rate | Monthly payment $150 |
4. | Student Loan | $10,000 | 5% Interest Rate | Monthly payment $100 |
This method focuses on paying off the highest interest debt first while making minimum payments on the rest regardless of the amount of debt. Once the highest interest rate debt has been paid off, you move on to the next debt payment with the highest interest rate.
The advantage here is that in the long run you end up paying less, but you do not see the regular successes as with the debt-snowball method. This method works if you are disciplined and are are more patient. The key here is to NOT continue adding more debts!
Using Both the Snowball and Avalanche Method
In this method you will pay down your debt like the snowball method as well as devote extra payments to your higher interest debt. The amount you split between the two methods will require a little analysis to see what the best amounts will be.
The result would be less money paid out in interest in the long-run and paying down your debt faster buy snowballing the payments. The more you devote to the Debt Method the more motivated you will probably be but more interest you pay. The more you devote to the High Interest/Avalanche method the less money you pay in interest, but you won’t see as many short-term victories.
So Which One is the Best?
It depends on your personality and have a level of self-awareness on what you prefer is the best way to pay down your debt: staying motivated over time or saving money on interest. If you can handle paying off debt without seeing regular successes initially, then choose the high-interest method since you will pay less money in the long run and pay it off quicker.
But if seeing regular progress and success is important to you now, then the debt snowball method is the best method to choose. And of course, if you can combine the two methods, to get the both of worlds. It will require some analysis and discipline to figure out the ideal amount to devote to each method.
Another method is combining the two methods. It is a bit more complicated but you can still stay motivated and lower the amount of interest you pay over time. The important thing here is that you have an active plan to pay down that debt and don’t add anymore!
4 Comments
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