Paying off debt can be nearly impossible if you do not concentrate your finances properly. Some debt accounts should be paid off quicker so that you can focus more on larger debt.
It is easy to become overwhelmed with bills coming at you every minute. This is why learning a few tricks about which debt to pay off first is beneficial for financial success. Having trouble deciding which debts to pay off first can be troublesome and create a sort of financial roadblock.
Self-discipline must be practiced to enforce paying off your debt faster. You are very well capable of getting your finances in order if you are serious enough. Cutting costs will seem impossible at first, but once you see how much money is being saved, it should give you a motivational surge.
Become obsessed with saving money as opposed to just spending. It is very easy to spend money on things you do not need, to impress your friends or neighbors, but how does it make you feel?
If your idea of life is to live large and spend every penny you make, then enjoy every second of it. Keep in mind when that income stops, so does living that fancy lifestyle. Too many people get into the notion of living the high life but never expect it to suddenly stop.
Living a modest way of life and saving wisely could ultimately lead to you retiring early with a million or more dollars in the bank. Arguably, this is what most people consider financial success, especially the ones who have lived a frugal lifestyle.
There are two common methods used for paying off debts. Both of these methods work however, one works much better than the other and will help you achieve debt relief faster.
Snowball Method
The Snowball Method is a debt reduction strategy aimed at paying off debts in a systematic and motivational way. This method is widely popularized by Dave Ramsey and seems to be the best route to go when trying to pay off debt.
The core principle of the snowball method relies on psychological triumphs that cause individuals to persistently pursue debt elimination. Targeting the smallest debts initially will generate a feeling of achievement and drive. This ongoing momentum aids in dedication to the repayment strategy.
As suggested by financial experts this method diverges from consistently prioritizing high-interest debts.
The Snowball Method typically works like this:
- List Your Debts. Start by listing all your debts (excluding the mortgage) from smallest to largest, regardless of interest rates.
- Minimum Payments. Make minimum payments on all debts except the smallest one.
- Attack the Smallest Debt. Put any extra money you have toward paying off the smallest debt. This could be from cutting expenses, selling items, or generating extra income.
- Snowball Effect. Once the smallest debt is paid off, take the money you were putting toward it (the minimum payment plus the extra amount) and apply it to the next smallest debt while continuing to make minimum payments on other debts.
- Repeat and Accelerate. Keep rolling over the amounts you were paying toward each debt as you pay them off, essentially creating a “snowball” effect, where the amount you can put toward the next debt grows larger with each one you eliminate.
The instant gratification of knocking out small debts quickly makes the snowball strategy alluring. Witnessing progress snowball can inject a dose of optimism and rekindle commitment to the debt-busting journey.
Prioritizing smaller debts over higher interest rates might lead to paying more in interest charges overall. This, in turn, can stretch the debt repayment timeline.
Avalanche Method
The avalanche method is a strategy used to pay off debts by prioritizing them based on their interest rates. It saves money on interest payments in the long run because it targets high-interest debts first.
This method delivers a double whammy, crushing your highest-interest debt first and slashing overall interest charges, ultimately saving you significant money in the long run.
By focusing on high-interest debts, you can pay off individual debts quicker, providing a sense of accomplishment and motivation to continue the process. Once the highest interest rate debt is paid off, move on to the debt with the next highest interest rate.
The concept is great for those who are financially disciplined and motivated by the idea of saving money on interest payments.
Getting started with the avalanche method is rather easy:
- List Your Debts. Begin by listing out your debts along with their corresponding interest rates.
- Interest Rates. Arrange these debts from the highest interest rate to the lowest.
- Minimum Payments. Make minimum payments on all debts except the one with the highest interest rate.
- Use Extra Money. Allocate extra funds toward paying off the debt with the highest interest rate aggressively.
Strictly following this method might not account for unexpected financial needs or emergencies, leading to inflexibility in managing your overall financial situation. Personal preferences and individual financial situations can play a role in determining the most suitable debt repayment strategy.
The initial progress might seem glacial compared to the snowball method, but remember, with the avalanche, you’re laying the foundation for a faster downhill slide toward debt freedom.
While targeting the highest-interest debt saves money in the long run, it can feel like pushing a boulder uphill. Seeing that large balance budge slowly can be demotivating for some.
Consolidation
In personal finance debt consolidation combines multiple debts into a single loan, usually at a lower interest rate, to simplify payments and potentially lower the overall interest costs.
Consolidation simplifies money management significantly. Rather than dealing with three separate credit card bills, each with different rates and payments, you merge them into a single payment.
This means your three payments transform into one, often reduced and at a lower interest rate.
Strategies like this can be instrumental in achieving success when budgeting and planning for your financial future. Dealing with constant monthly payment reminders or bills can be daunting.
Even if you still have debt, this approach can offer psychological relief by minimizing the need to manage multiple payments for the same amount of debt.
Pros:
- Simplify Payment. Combining multiple debts into one payment makes managing finances easier.
- Lower Interest Rates. If the new consolidated loan has a lower interest rate compared to the previous debts, it may save money in interest payments.
- Improve Credit Score. When managed well, debt consolidation can positively impact credit scores by reducing the number of accounts and improving payment history.
Cons:
- Extended Repayment Period. Consolidating debt might extend the repayment period, resulting in paying more interest over time.
- Risk of Accumulating More Debt. It can create a false sense of relief, leading some individuals to accrue more debt on top of the consolidated loan.
- Potential Fees. Some consolidation options might involve fees or charges, impacting the overall savings.
Consolidation simplifies accounts but demands thoughtful evaluation of potential downsides before moving forward.
Debt Relief Programs
Debt relief programs work to assist individuals and businesses struggling with overwhelming debt by reducing the overall debt burden, negotiating with creditors, and creating a manageable repayment plan.
There are several types of debt relief programs:
- Debt Consolidation. Combines multiple debts into a single loan, often with a lower interest rate, making it easier to manage payments.
- Debt Settlement. Negotiations are made with creditors to settle debts for less than the total amount owed. This typically involves making a lump-sum payment or structured payments.
- Debt Management Plan (DMP). A credit counseling agency works with creditors on behalf of the debtor to establish a repayment plan with reduced interest rates or waived fees.
- Bankruptcy. A legal process that can discharge certain debts, offering a fresh start for individuals or businesses. However, it can have long-term consequences on credit and financial stability.
Debt relief programs can be a valuable tool, but it is crucial to understand the potential downsides.
Some can negatively impact your credit score, and eligibility for reduction or negotiation varies greatly. Additionally, associated fees can add to your financial burden.
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Resources:
- Investopedia
- Experian
- Featured Image Courtesy of Free Stock photos by Vecteezy