Finance & Insurance

The Two Best Ways to Payoff Debt

debt

As the weather warms up, you’re likely getting out more. As you’re getting out more, you’re likely spending more money.

It’s like If You Give a Mouse a Cookie, except this story has the potential to end with overspending, a closet full of shoes you don’t necessarily need, and a pile of receipts leftover from eating out. Overspend enough, and you could find yourself in debt.

If you do find yourself in that position, it’s okay to freak out. It’s okay to cry. It’s okay to feel depressed. After you allow yourself to feel those things, though, it’s time to take action.

There are two basic schools of thought when it comes to the best ways to pay off debt. One of them is based on straight mathematics. The other is based on behavioral finance. Read on to find out which one is right for you.

Debt Avalanche

The Debt Avalanche is the mathematical approach. First, you look at your debts’ interest rates. You pick the debt with the highest interest rate and pay it off first as it is costing you the most money, even if it’s not the highest balance.

Let’s say you were putting $200 per month towards that debt and minimum payments of $74, $52, $67, and $20 towards your additional debts respectively. Once you finish paying off that first debt, you can now apply it to the $74 debt with the next highest interest rate. You’re now paying it off at a rate of $274 per month which will get it eliminated much more quickly.

By the time you get to the next debt, you’ll be able to allocate $326 towards it per month. You go on until you’re paying off your final debt at a clip of $413 per month. Each debt you pay gets eliminated at a quicker pace, and because you’re paying off the debts with the highest interest first, you are paying the least amount of interest possible for the predicament you’ve found yourself in.

Debt Snowball

The Debt Snowball method has you pay off the debt with the smallest balance first so that you’ll feel good about your progress. When you use this method, you will have paid more in interest by the end than you would have if you had used the Avalanche method, but its proponents say that the psychological win of killing off a small debt quickly encourages more people to stick with it.

In our case, we’ll assume that smaller minimum payments mean smaller debts. That means we’d start with the $20 debt, then pay off the higher ones incrementally ($52, $67, $74, and the big one that came with the highest interest rate.)

This method will cost you more money. But you’ll be able to see progress sooner. This is the method Dave Ramsey encourages as a method is only mathematically sound if you stick with it, and he feels that people will stick with the Snowball method more consistently than the Avalanche. If you want more of his payoff-debt advice, check out some Dave Ramsey courses here.

Which one is right for me?

You are the best person to answer that question. If you’re motivated by paying the least interest and know that you will stick with it consistently enough, the Debt Avalanche method will save you more money.

If you know yourself well enough to know that you’ll get frustrated and stop making progress if you aren’t seeing quick wins, then you’ll probably want to pursue the Debt Snowball method.

Neither solution is right or wrong. In the end, they’re both eliminating debt, and that’s a very good thing.