Today we are talking DEBT PAYBACK, snowballs, and avalanches. I believe there are good kinds of debt, but also bad kinds. And I recently have been listening to various conversations in my industry and advice for people who are in debt. The average U.S Household has nearly $7k in credit card debt and is paying over $1k in interest each year. The average is $28k for auto loans, and $47k for the average student loan. And these numbers are rising. Today I wanted to discuss some of my thoughts, specifically on how to pay off debt.
To me, paying off debt is all about balance. Balancing your debt payback, versus savings, versus money being used to live on. And until it goes away, debt can limit your progress on moving forward.
The assumption here is that we all want to get rid of our debt and move on. After all, there are other ways to deal with debt other than paying it off. But do you really want to use credit card balance transfers or get a personal loan to replace your credit card debt? Bankruptcy is an option, but I wouldn’t recommend that unless you had ZERO options left. We’re assuming we want to pay back our debts.
First, it is important that you make a list of all the debts you currently have. We can probably leave house payments out of the equation for now, as this primarily discussion is based around credit card, student loan, car payments, medical bills, etc. Your list should include the interest rates, the minimum payment amounts, and total amount due to the creditors. Once you have this list, analyze it and get mentally prepared to make it all go away (eventually).
I am making a presumption here that you are already making at least the minimum payments toward each item on that list. Ideally, you have extra money each month that you can use to pay more than the minimums for at least one of the items on that list. And if you get a bonus or some other unexpected cash windfall – plan on attacking these items more aggressively. But for now, understand the task at hand. The task is knocking out that list of debt sitting in front of you.
Next, we have to figure out the plan of attack. I’d recommend ranking the debts in order in which you want to pay them off. How to do this? Well, surprisingly enough – industry experts have differing opinions on which system makes the most sense. I’ll tell you about the first one, then I’ll follow that with the method that I prefer. This is where snowballs and avalanches come in.
The idea of the “debt snowball” is paying the debts so that you are paying the smallest ones first, and working your way towards paying the largest debts. The primary argument for this approach is that it helps get the momentum going. From a psychological standpoint, the “wins” of paying off debts feel good and helps people see progress. And smaller debts are easier/quicker to pay off than larger debts. Therefore, people are able to continue the momentum until all debts are relieved.
However, crunching the numbers using the “debt avalanche” method appeals to numbers nerds like me. Ranking the order of debts to payoff is a matter of paying off the highest interest rate debts first. So you would pay down a $10,000 loan with 15% interest, before a $5,000 loan with 10% interest or a $1,00 debt with 5% interest. Mathematically speaking, this method pays down your debt faster and with less interest payments. For an analytical guy like myself, this makes the most sense and the one I would recommend to most people.
However, since most people are not rational when it comes to money (and other things for that matter) different motivation is needed. If you are more motivated seeing small wins, maybe the snowball approach is the way to go. To each their own but review the pros/cons …I won’t argue with you, I’m just more of a dollars-and-cents kinda guy.
Once you have chosen your preferred method, get to work. Focus on paying one debt off at a time, and stick to it. If your income and ability to pay is consistent, there are online calculators you can use to estimate when you can expect to pay them off. Have the ability for side hustle or working overtime? Great – let’s put that to work too. Stay on point and continue to pay the minimums to all debts, while adding extra payments to the debt-of-the-moment. It is critical that you focus on one debt at a time, as there is no real need to try to pay two or more simultaneously.
When an initial balance is cleared (wiped out, dunzo), move on to the next. The debtor should do this until they go through all the debts off the list. Feeling good now? Good! Congrats! You should feel good, you just knocked out your debt.
But a major word of caution – don’t get back into this debt position! It’s similar to losing weight and fighting to get back in shape – you probably don’t want to slack again because you will have to fight tooth and nail to get back to normal. Maintain your discipline, build up your savings, and keep your spending in check.
Listen, I don’t propose people get into debt in the first place…but it’s probable, and perhaps unavoidable, that you will be in this position at some point. So, be smart about it. Try to be rational about it. And if you need help, talk to someone about it.