One of my favorite things to do is to answer questions from my readers! If one person asks, it usually means there are many more who want to. This great question showed up in my inbox a few days ago:
How do you best recommend to get out of our credit card debt? Cold turkey, combining onto a new card with a lower rate, or just paying on each one?
There are three common ways to pay down your debt:
Lowest Balance First (Debt Snowball)
This method of tackling your debt is recommended by Dave Ramsey. While it is not the most mathematically sound method, it does work. When it comes to being overwhelmed with debt, logic isn’t always the best solution so you need to do what works for you. When using the debt snowball method you will pay the minimum on everything and put everything extra towards the smallest balance.
PROS – Using the debt snowball method will allow you to cross entire items off your list of debts more quickly since you are tackling the smallest amounts first. This will give you a mental boost every time you pay off a debt.
CONS – On the other side, the debt snowball method may leave you paying down a 5% loan instead of the one you are paying 20% on simply because it is a smaller amount. This will cost you more money in the long run.
Highest Interest First (Debt Avalanche)
This debt repayment method is the most logical. If you get rid of the highest interest rate credit cards first then you will saving the most money. In the highest interest rate first method you list out your debts in order of highest to lowest interest rates. Pay the minimum on everything and the extra payment goes toward the debt with the highest interest rate. When that debt is gone you move down the list.
PROS – This debt repayment method is the most mathematically sound. Compared with the other methods you will pay the least amount of money back.
CONS – If your highest balance card has the highest interest rate then it might be years before you pay something off completely. Even though you are paying down on your debt, it can be frustrating to not see one disappear.
Splitting The Extra Payment Across your Debt
This method splits all the extra money you have between all of your accounts so you are paying your debts at the same rate. Personally, I am not a fan of this method. They will be paid off about the same time, which is a plus, but there isn’t a mental or financial reason to do it this way. In this method you will be paying the minimum on everything then evenly splitting the extra payment and adding it to the minimum for each debt.
PROS – honestly, there really isn’t one that I can think of
CONS – It is hard to see progress. If you have five cards and an extra $100 each month then that extra $20 on each card is harder to see than $100 on one card.
Use the debt repayment method that works for you
You do not have to follow a single debt repayment method. If you need a mental boost then go for the small amounts! If the amounts are $500 apart and one is 15% and one is 8% then pay off the 15%!
If you do find yourself in debt then call your credit card company to see if they will lower your interest rate for you. Many companies are willing to work with you (they would rather have a paying customer with a lower interest rate than a customer in bankruptcy). If they say no then you are out nothing. If they say yes then a lower interest rate will save you a lot of money in the long run!
Run the Numbers!
If you are unsure what the best method is for you (or you just want to be sure) then run the numbers! It may surprise you. Here is an example and how you can run the numbers:
This couple has the following loans (not including their mortgage debt)
- Student Loans $14,000 at 2.0% – $163 payment
- Auto Loan #1 $9,000 at 4.0% – $165 payment
- Auto Loan #2 $17,000 at 6.0% – $328 payment
- Credit Card #1 $10500 at 20% – $280 payment
- Credit Card #2 $5000 at 10% – $91 payment
Total payments each month = $1027
First, go to Bankrate.com and use their calculators. It will make this process simple! Let’s say you have $1500 to spend on your debts each month (an extra $473 in the beginning)
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