Once you learn how to budget, especially when you use the Fiscal Fitness Phoenix Budgeting Method, you tend to notice you have a lot of extra money at the end of the month. Your budget should show you exactly how you should be paying expenses on payday (not on the due date), using cash (check out our podcast episode on using cash here) to pay for day-to-day spending, and saving for random and non-recurring expenses like home repairs, auto repairs, gifts and vacations. When you are budgeting for all of these expenses, you should have extra money in hand.
Our challenge to our clients is to set a goal to direct you on what you do with that extra money. It could be extra towards retirement and investments, vacations or your kids’ college funds. But for a lot of people, their first goal is to pay off debt. Student loans, credit cards, car loans, high-interest title loans and mortgages are all types of debt that people want to get rid of quickly. (Contrary to popular belief, student loans are not really “good debt”, but we will talk about that another time).
Below we’ll explain four different debt payoff strategies that each have their benefits. The difference between their benefits depends on a person’s unique financial situation. Some people are very motivated and want to get rid of their debt as fast as possible, no matter the sacrifice. Other people need a quick win to stay motivated throughout the process and need a different strategy. And there’s a debt payoff strategy for each.
Debt Payoff Strategies
There are four major debt payoff strategies, listed below in no particular order.
Made popular by Dave Ramsey, the Snowball method prioritizes paying off your smallest debt first and then rolling that payment into your next highest debt.
Who it’s best for:
This method works best for those who love instant gratification and need quick wins to stay motivated. You will pay off small debts quickly which confirms what you are doing is working.
How it Works:
Organize all your debts’ remaining balances from lowest to highest. Pay the minimum payments to all balances except the lowest remaining balance. Throw all extra money at that debt. Do this until that debt is paid off. Then throw all extra money at the next lowest balance, and so on until you are debt free.
Made popular by Suze Orman, the Avalanche method prioritizes tackling your highest interest rate debts first. This method works well for people who are driven to get out of debt and don’t need a quick win to stay motivated.
How it works:
Organize your debts by the highest interest rate to lowest. Pay the minimum payment to low-interest rate debts and the most that you can to the debt with the highest interest rate. These high-interest rates cost you extra money each month, so if you eliminate the highest debt first you have even extra money to pay off debt each month.
This strategy allows you to pay off the debt that is costing you the most money because of the high-interest rates.
This strategy is favored by “Rich Dad, Poor Dad” author Robert Kiyosaki. It says that you list your debt in order of highest payment to lowest payment (excluding real estate) and pay off the highest payment first.
How it Works: Organize all your debt from highest payment amount to lowest payment amount, excluding real estate. Pay the minimum payments to all debt except for the highest payment amount debt, which you throw all extra money at until it is paid off, then start again with the next debt and so on.
Who it’s best for:
This method focuses on your monthly payment amounts and is good for someone who has a very tight budget without a lot of wiggle room. The Kiyosaki Method gives more breathing room to cover unexpected expenses by freeing up cash quickest.
Emotional Baggage Pay off
Created by our very own financial coach Kelsa Dickey, the Emotional Baggage method prioritizes paying off the debt that is emotionally toxic. Maybe it was a personal loan gone bad or it’s payments to an attorney after a particularly nasty divorce. Regardless of the reason, interest rate or amount, give yourself permission to get that out of your life by paying that debt off first.
How it Works: Pay the minimum amount on all your other debts and pay all extra money towards the debt that makes you feel the most negative emotions. Once you have eliminated that debt, switch to another strategy that best fits you.
It will reduce the most stress and help stop you from reliving a bad decision.
Not all debt payoff strategies work for everyone.
If you want to figure out which strategy is best for you, take our free debt payoff quiz here.
Common Mistakes When Paying Off Debt
Regardless of which method works best for you and your financial situation, we want you to be aware of a few common problems and some errors we frequently see when people are working to pay off their debt.
Divide and Conquer
If you have multiple debts the worst thing you can do is try to pay a little bit more than the minimum towards all of them. When you do this, you divide your money and don’t conquer anything. The best option is to pick one debt to pay off, pay the minimums on the rest and throw every extra penny on the one debt that you chose to tackle first.
Not Saving for Random and Non-Recurring Expenses
A tenant of the Fiscal Fitness budgeting system is setting aside money every month to go to different expenses that don’t occur every month. Some examples of non-recurring and random expenses are subscriptions, clothing, vacations, house repairs, car repairs, taxes, licenses, and registrations or semiannual insurance premiums. Basically, this is anything that can happen unexpectedly (like your car breaking down) or anything that doesn’t happen monthly (like an annual car insurance payment). The idea is that these are expenses that ARE going to happen but are never budgeted. When these expenses come up, you typically have to put them on a credit card. Budgeting for them breaks that cycle.
You may say “but how can you say save for clothes or vacations before you pay off debt?” Let me pose this question to you: Say you cleared out your checking account of that extra money at the end of the month to pay off a credit card and didn’t put anything towards your random/non-recurring expenses. Then say you end up having to have your car repaired. How are you going to pay for that? Yup, with your credit card. Thus starting the credit card debt cycle all over again.
It’s important to set aside money monthly for these expenses, and the best way to do that is to come up with a yearly average for each expense then divide by 12. This is the amount to set aside each month.
Changing Pay Off Strategies Mid Payoff
This happens most often because you hear a famous financial guru make a recommendation, read an article about some new financial rule, or talk to a friend who has paid off his or her debt. They say, “Don’t do it that way. The best way is this way.” But don’t listen to them. Choose your debt strategy and stick with it. Changing midcourse will only cause frustration and decrease your motivation.
Just Keep Going
If you are paying off debt, you are doing it right. There is no right or wrong way to pay off debt. Each person has to choose what fits their life and their personality best. Stick with it and throw all your extra money at that one debt you choose (after saving for random expenses) and you will get there! Good luck!
If you want help figuring out which debt payoff strategy works best for you and how our financial coaches can help you create a plan to pay off your debt, learn about our Eureka sessions here.