Recently, we talked about using savings from reduced expenses to pay off consumer debt. But if you have multiple sources of debt (credit cards, student loans, car loans, lines of credit, mortgages, etc.), you might be wondering about the best way to tackle them.
There are 2 main orders in which to pay off debt:
1. By balance (from smallest to biggest), aka the ‘Debt Snowball Method’
Pro – you can quickly knock off debts, giving you motivation to keep going.
Con – it can cost you more in the long run if you’re paying lower-interest debt ahead of higher-interest debt.
Bottom Line – best debt payoff strategy psychologically-speaking.
2. By interest rate (from highest to lowest)
Pro – minimizes the amount of interest paid overall.
Con – it can feel like you’re not making any progress if your highest-interest debt happens to have a large balance, and you might be tempted to give up.
Bottom Line – best debt payoff strategy mathematically-speaking.
Obviously, neither way is wrong, and the strategy you choose will depend on your personality (for example, I need ‘quick wins’, so for me, it’s all about the DSM).
Whichever method you choose, you’ll need to:
a) Make a list of each of your debts, noting the balance owing, interest rate and minimum monthly payment.
b) Order the list according to your chosen strategy.
c) Make minimum payments on every debt on your list.
d) In addition to c), throw as much extra $$ as you can at the debt at the top of your list.
e) Once the top debt is paid off, put all of the money that was going towards that top debt (the minimum payment + extra $$) towards paying debt #2, in addition to the monthly payment you were already making on debt #2 (hence the ‘snowball’).
f) Repeat step e) until every single debt is paid!
Sounds simple, doesn’t it?!?!
Now go forth and slay, financial samurais!