If you’ve decided to work your way out of debt, just getting organized to understand how much you owe can be challenging. Between different lenders for your student loans, multiple credit cards, a line of credit, car loan, payday loans, and a mortgage, figuring out exactly what your debt number is can be confusing.
Even more confusing is how best to pay it off. There are two main schools of thought on the issue – let’s take a look at both and see which one might be better for you.
High Interest First
Every loan you have charges you interest, probably at wildly differing rates. Credit card debt can easily be in the 20% – 30% range, student loans might be 6% – 8%, a line of credit could be 6% – 10%, and a payday loan can be off the charts.
You should quickly realize that the higher the interest rate, the more money it’s costing you, and you should tackle that one first.
This makes complete mathematical sense. In this case, you’d want to lay out all your debts, then organize them highest to lowest based on the interest rate.
Then you’d pay minimums on everything and throw every extra dollar you can at the first one on the list (the one with the highest interest rate). Once that’s done, you’d take all the money that was going to number one, and throw it at number two (which is now number one).
By going through your debts this way, you’re getting the biggest bang for each buck. Not only does every dollar help pay down the debt, it also cancels out the higher interest charge that that dollar would have cost you.
The Snowball Method for Getting Out of Debt
OK, maybe you’re good at math and still have some debt. The real issue then is not having the best spreadsheet. At a fundamental level, the problem is your behavior, not math. You KNOW what you should be doing, it’s just too hard to keep hammering at it.
Something always comes up, and there’s always a ‘good reason’ to borrow more money or not pay down your debts. This is behavioral, and no amount of logical math is going to change it.
The snowball method takes a different approach. Rather than ordering your debts largest to smallest based on interest rate, you’re going to order them from smallest to largest based on total amount owed.
The reason for this is simple:
Go for some easy wins to build your excitement about getting out of debt.
Most people in debt have some really small ones. Maybe you owe $200 on your Home Depot credit card, and another $350 on a Sears card. Then you owe $2,700 on your car, $7,600 on your student loan,
and $11,000 on your line of credit.
Starting off, you have 5 loans. If the line of credit has the highest interest rate (unlikely, but play along), then the high interest first method would say go after that one first.
But doing that means you’d be stuck with all five loans for quite a while, and knocking out an $11,000 loan a bit at a time is depressing.
Compare to the snowball method. Let’s say you pay the minimums on all your debts and have $200 extra to pay them down with. Well in month 1 you clear the Home Depot card. Next month you pay the minimum on everything, and the Sears card gets that minimum plus the minimum from the Home Depot card, plus the $200. In two months that one’s gone too.
You’re three months in and you’ve gone from 5 loans to 3. That’s exciting! Plus you’re now paying down the car loan even faster.
The “snowball” effect means each debt becomes easier and easier because you’re throwing more and more money at it. Psychologically, this is exciting, and you’ll start working even harder, maybe doing some overtime, finding a part-time job, selling some stuff, or whatever else to keep the momentum going.
It might not be the most mathematically logical thing to do, but it will override your doubts and motivate you to keep going – and that’s something that the logical solution just won’t do.
Which is for me?
By now you should have a good feeling for which solution is best for you. If you’re convinced you’re disciplined enough to follow the math, then go for it. If you’ve had constant setbacks and have a hard time sticking to a plan, try out the snowball method and go for the quick wins.
If you find that no matter how hard you try, you just can’t seem to get ahead, then it may be time to contact a professional who can help you become debt free. Receive a free debt consultation by filling out the debt relief form on our website.