As a nation, we have $357 billion in credit card debt, $1.44 trillion in car loans, and $1.58 trillion in student loans.
How do I pay off all of this debt? Clearly, this is a question with which numerous people are, or should be, wrestling. For many, being debt free seems too daunting and unfeasible to even consider. The method to becoming debt free must be incredibly complex, right? Wrong. In fact, the two most popular methods of paying down debt are incredibly easy to understand. Let me introduce you to the snowball and avalanche methods.
The Debt Snowball Method
Let’s assume that you have four debts:
· $126,000 mortgage with a 6% interest rate
· $5,000 credit card with a 20% interest rate
· $7,500 car loan with an 8% interest rate
· $300 credit card with a 15% interest rate
The debt snowball method says you let debt balances determine the debt payoff sequence. Debts with lower balances are paid off before debts with higher balances. While focusing on one specific debt balance, make the minimum payment on all other debts. In this scenario, the order of debts to be paid off will be:
1. $300 credit card with a 15% interest rate
2. $5,000 car loan with an 8% interest rate
3. $7,500 credit card with a 20% interest rate
4. $126,000 mortgage with a 6% interest rate
Like a snowball rolling down a hill, the idea behind the debt snowball method is momentum creation. There is excitement created by paying off a debt. This excitement develops a “can do” attitude that motivates debtors the next debt balance. The excitement of paying off your $300 credit card will provide motivation to pay off the $5,000 car loan.
Research has shown that the debt snowball method is the most effective method for paying off debt. However, there are advocates for other methods, like the debt avalanche method.
The Debt Avalanche Method
In the debt avalanche method, you let interest rates determine the debt payoff sequence. Debts with higher interest rates are paid off before debts with lower interest rates. As with the other method, make the minimum payments on all other debts. Using the prior debt scenario, the payoff sequence would be:
1. $7,500 credit card with a 20% interest rate
2. $300 credit card with a 15% interest rate
3. $5,000 car loan with an 8% interest rate
4. $126,000 mortgage with a 6% interest rate
The benefit to the debt avalanche method is monetary savings. Simply put, the higher interest rate, the more you pay. So by eliminating the higher rate balances first, you end up paying less on your cumulative debt.
While I prefer the debt snowball method, both methods have their merits. The common idea found in both methods is to focus on one debt at a time. So when choosing which method to use, I recommend asking yourself, “What motivates me more?” Does the thought of seeing a zero-balance get you excited or are you more motivated the thought of reducing the amount of interest you pay?
Whichever thought motivates you more, choose that one.
Here is what I know you should not do—choose not to fight. Life is too short to be burdened by loads of debt and God demands our stewardship. The methods are simple. It may take some time, but you can do it. It is just a matter of starting.