Three Popular Methods to Paying off Debt

When it comes to paying off debt, you need to find a strategy that works for you. I’m sure you’ve heard the saying a “goal without a plan is only a wish” before and in this situation, that definitely applies. Sure, you can just throw any extra money you have at the debt and hope it works out for the best but it is much easier to make progress toward your goals with an actionable plan in place. The strategy you choose comes down to personal preference but I’ll cover three common methods and their advantages.

Debt Snowball Method

Imagine a snowball rolling down a hill. You start off with a small snowball and as it rolls, it quickly grows into a much larger ball. This debt payoff method is much the same. You start by paying off your smallest balance first and as you go, you roll that payment into the next one, which can quickly grow into large payments as you pay down your debts. One of the biggest perks of this method is that you see progress quickly. This method disregards interest rates and solely focuses on paying off your smallest balance to your largest. Because of this, your first pay off can come much quicker than the other methods. For some people, that can be very motivating to keep going. You may end up paying more in interest in the long run but having those early wins can be a worthy trade-off. Let’s use an example to show the different methods , how long they will take to pay off, and total interest.

Let’s assume we have 3 debts. 1 credit card with a balance of $4,000 at 12% interest and a minimum payment of $100. A second credit card with a balance of $7,000 at 18% interest and a minimum payment of $140, and a personal loan with a balance of $5,000 at 10% interest and a monthly payment of $150. Now let’s assume we have $800 per month to put toward our debt. Using the snowball method, we’ll focus on paying down credit card 1 first, putting all excess toward that debt and making only minimum payments on the other two debts. It would take 9 months to pay off this credit card. Afterward, we would take the $500 we were paying on credit card 1 and roll that into our second debt, the personal loan. We’ve already been making minimum payments on the loan for the past 9 months so now by increasing our monthly payments to $660, it will an additional 6 months to pay off this loan. The same concept applies to our last debt, the second credit card. After 15 months of minimum payments, we’ll now roll the $660 we were paying toward the personal loan into this payment, making our monthly payment $800. It will take another 8 months to pay off this debt. In total, it took us 23 months to pay off everything and resulted in $1,965.87 of interest paid.

Debt Avalanche Method

The debt avalanche method focuses on interest rates and ignores starting balances. Using this method, you pay off your highest interest debt and work down to your lowest interest debt. The idea here is to cut out as much interest paid as possible, ultimately saving you money. This method can often look like paying off one of your higher balances first, which can mean taking longer to see that progress or feel that win of completely paying off a balance. This method may be right for you if you are more concerned about savings as much money as possible over seeing progress quickly. Let’s use the same debts from the last example to show how long it will take to pay off these debts and how much they will ultimately cost.

In this scenario we have the same 3 debts and $800 a month to put towards our debts. This time, we’re going to start with our highest interest debt, Credit Card 2. Our total monthly minimums are $390, so we have $410 to put toward our monthly payment of Credit Card 2 on top of the $140 minimum payment, so we will begin with monthly payments of $550. This will take us 14 months to pay off. Now we’ll roll our $550 a month into our next highest interest debt, Credit Card 1, and begin making payments of $650 a month towards that debt. This will take an additional 5 months to pay off. Finally, we’ll roll that $650 into our last debt, the personal loan, and increase our monthly payment to $800. This will take an additional 4 months to pay off. In total, it took us 23 months to pay off all of the debt and resulted in $1950.54 of interest.

As you can see, this method took the same amount of time as the snowball method and only save about $15 in interest. However, it did take 5 months longer to see the first pay off. The amount of interest can be greater if there is a larger discrepancy in balances and interest rates, but in this case, the savings is almost negligible. If you are torn between these two methods, it may be worth running the numbers to see if the savings is worth going this route.

Debt Consolidation Method

The third method to paying off debt worth mentioning is the debt consolidation method. This method involves taking out a personal loan to pay off credit card debt so that you have one monthly payment instead of several. This method can be advantageous if you are able to get a personal loan at a significantly lower interest rate than you credit card interest rates. If you have 3 cards with interest rates between 20-25% interest, a 9% interest personal loan can save you quite a bit of money in interest. The key here is to pay more than your minimum monthly payment on the loan (making sure that extra payment is going to principal) to pay down that loan as quickly as possible. For example, if your card monthly minimums were $100 more than your new loan payment, paying an amount equal to those minimums can help you pay down your loan faster and save you even more in interest,

A quick disclaimer: this method isn’t for everyone and if you have a hard time not running a balance on your cards, this may not be the method for you. You don’t want to go through the work of consolidating this debt just to find yourself in more debt. The debt snowball or debt avalanche method may be a better fit.