If you ask my husband the best way to pay off debt he will tell you, “With money. Boom.” (He’s funny.) Unfortunately, it’s not that simple. Yes, you do need money for paying off debt, but you know what else you need? A plan.
Most people struggle to get out of debt because they don’t have a good roadmap for actually getting out of debt. Unless you have a concrete set of plans to follow, you’re winging it, and chances are it’s going to take you a lot longer to pay off your debt, no matter the amount.
Debt Payoff Strategies
Not all debt is created equal and not everyone’s financial goals are the same. Because of that, there are several different strategies for deciding which debt you tackle and how to pay it off.
Popular Strategies: Avalanche vs. Snowball
The Avalanche Approach
The avalanche approach has you put your debts in order of interest rates and pay the one with the highest interest rate first. This strategy results in the lowest total interest paid. It is the preferred method by popular author, TV, and radio host Suze Orman.
The Snowball Approach
With the snowball approach, you list your debts in order of overall balance and pay the credit card with the lowest balance first, ignoring the interest rates. The main benefit of this approach is the “immediate gratification” because you start to accumulate wins more quickly. This method has been around for a long time, but it’s been made popular by author, TV, and radio host Dave Ramsey.
These methods work great for some people yet are totally wrong for others. They look at the interest rate or balance of your debts while ignoring other important other components.
Other Important Things To Consider When Choosing a Debt Payoff Strategy
Payment Amounts
If you owe $2,500 on a credit card at 15% and $2,600 on a car loan at 5%, both the Avalanche and Snowball approaches would say you payoff the credit card first. However, your monthly payment on the car is likely much higher. That means even without making any extra payments, you’re chipping away at the balance on the car at a faster rate.
Because of that, it may make sense to throw extra money to the car instead of the credit card. Plus, wouldn’t it be nice to free up the monthly car payment going forward? If the car is paid off first, you now have more money to pay toward the credit card which then helps you tackle your credit card even quicker.
Your Emotions
Have you ever owed a friend or family member money? If so, then you know better than most that the interest rate, balance, or payment amount don’t really matter. The emotional baggage of this debt may mean it should be paid first even if it doesn’t make sense mathematically.
Your Own Determination to Succeed
Some of my clients are so frustrated, disappointed or just plain sick of being in debt they’re going to pay it off no matter what gets in their way. If that’s the case, the Snowball approach may not be necessary. They don’t need “immediate gratification” and they are likely to pay less in interest by paying off a debt with a higher interest rate first.
The Tax Consequences
If one of the debts on your list is a student loan, you may be deducting the interest on your tax return each year (discuss this with your accountant). When ranking your debts in order of interest rates, this is something to consider.
If the interest rate on your student loan is 6.5% yet you deduct the interest you pay, then your actual interest rate is slightly lower. You may need to change your rankings accordingly if another debt is also listed as 6.5% but doesn’t have an interest deduction.
What’s the Best Debt Payoff Strategy?
The best approach to paying off debt is one that is completely customized to you and your situation. If debt payoff is your goal, take all of the above factors into consideration. All this information is key to helping you choose the strategy that’s best for you. Feeling confident in your debt payoff strategy means you’re more likely to succeed.
Need help determing which debt payoff method is best for you? Take our free debt personality quiz here.
What’s the Second Best Debt Payoff Strategy?
The next best approach to paying off your debt is simply one that you stick to until your goal is accomplished. This idea of “divide and conquer” doesn’t work when it comes to debt. If you divide your extra payments among all of your debt, you end up not really conquering anything.
Choose a debt, whether it’s the one with the highest interest rate, lowest balance, most emotional baggage, or biggest payment…just pick one, pay the minimums on the rest and throw everything extra to the debt you chose. Tackle it until it’s completely gone, then move onto the next one. Try to resist the urge to change strategies. Don’t change just because you read an article or talked to a friend who said to do it differently. Consistency is key.
At Fiscal Fitness, we have helped hundreds of clients over the years figure out which debt payoff strategy is right for them. We show clients the good, the bad, and the ugly of each strategy. We can project how the timeline changes or the total interest charges based on each approach. We can even tell our clients when they will reach certain milestones, such as when one debt will be gone, using one strategy versus another.
The order you pay off your debts may result in differences that are considered insignificant such as $20 in total interest or a one-month payoff time-frame. But that might not be insignificant to you. Wouldn’t you want to know?
If you’re struggling with how to pay off your debt, check out our Eureka session and schedule one-on-one time with one of our financial coaches.
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