Getting Out of Debt: Step 2

Updated: May 13, 2018

How to Pay off Debt

We previously showed you how start getting out of debt by not accruing anymore debt, facing your debts, along with starting and sticking to a budget.

Debt Payoff Plans and Options

Strategy 1: High Interest Debt Payoff Method (Avalanche Method)

This method allows you to payoff your high interest rate debt first. When followed with discipline, it leads you to paying the least amount in interest. Here’s how it works:

  1. List your debts, in descending order by interest rate, regardless of how much each debt is.

  2. Pay off all minimum amounts for each payment period for each debt.

  3. Apply all available income towards the highest interest debt.

  4. The more you can apply towards high interest debts, versus low, the more money you are saving. This savings will allow you to pay off your debt faster.

  5. Once your highest interest debt is paid off in full, move to the next highest interest debt and work your way down to the lowest.

Strategy 2: Smallest Payment First Debt Snowball Method (aka The Dave Ramsey Debt Payoff Method)

The debt snowball method, by Dave Ramsey, is to stop paying everything except your minimum payments and focus on paying off the smallest debt that you have quickly, then gradually build your way up to the largest. Here’s how it works:

  1. List your debts in ascending order with the smallest balance first, ascending to the highest balance debt amount.

  2. Pay the minimum amounts for each payment period for each debt.

  3. Pay off your smallest debt, which should also be the one that you can pay off first.

  4. After your smallest debt is paid off, move up in order from smallest to largest.

  5. In theory, getting rid of small debts quick builds up ‘momentum’ to encourage you to stay interested in getting rid of debt. Getting out of debt is emotional and psychological rather than rational. This is the ‘debt snowball’ that Ramsey talks about.

Strategy 3: Debt Consolidation Payment Method

This method is a way for you to ‘lump’ all of your debts into one large debt that you can focus on, usually with a high interest. Debt consolidation is a huge, and many times, shady, industry. The promise is that you will be able to combine all of your debt into one low interest payment loan.

If you have enough bad debt to consolidate, you will typically not have good credit. This means that you’re most likely going to get a high interest rate, and/or pay a ton in fees.

What is the Best Debt Pay Off Strategy?

It depends on your amount of debt, your needs and your goals. Some people want to save the most money on interest, and choose the Avalanche Method. Others need to start small and see results and the satisfaction of having a debt, even if it small paid off completely. They choose the Snowball Method. You have to evaluate your debt, your income, expenses and budget and choose which option or combination of both is best for you.

Disclaimer: The content on this site is provided for information and discussion purposes only. It is not intended to be professional financial advice and should not be the sole basis for your investment, financial or tax planning decisions. Under no circumstances does this information represent a recommendation to buy or sell securities, or any other products, or services. All content and information is subject to change at anytime.