Welcome to Debt Elimination Tips – a new weekly series here on Disease Called Debt!
Each week, I’ll be sharing a quick and easy tip which you can use to get out of debt faster. If you missed last week’s tip about overpaying your debts weekly, check it out here!
Today’s debt elimination tip is about deciding on and executing a debt reduction plan which will help you stick to your goal of getting out of debt.
Like any goal you’re working towards in your life, a plan will help you to get there. It’s exactly the same with getting out of debt. You might have the very best intentions and be working hard to pay more than the minimum payment on your debts, but without a plan, you’ll probably fail or give up at some point.
I failed several times at getting out of debt. I really did try so hard for a number of years by cutting back on my costs and giving up my social life in fits and starts. But ultimately, I failed over and over again because I gave in or something came up which led me to brushing the debt back under the carpet, where it started to grow and multiply again.
Then I stumbled across a piece of information on the internet about using a debt ladder approach (I’ve since learned this is the same as the debt snowball approach) to paying off debt which was my first glimpse into getting a proper structure in place to help me get out of debt for good. It worked!
Different ways of paying off debt
Let’s assume we have a number of debts which look like this:
- Credit card debt – £10K @ 13% APR
- Car finance debt – £4K @ 5% APR
- Unsecured loan debt – £5K @ 4% APR
- Overdraft – £1K @ 19% EAR
Pay the highest interest debt first
This method of debt reduction makes sound financial sense. By paying off the highest interest rate debt first, overall you’ll be paying less money back to your creditors. In this case, you’d be paying off the above debts in the following order:
- Overdraft – £1K @ 19% EAR
- Credit card debt – £10K @ 13% APR
- Car finance debt – £4K @ 5% APR
- Unsecured loan debt – £5K @ 4% APR
The only problem with paying off the highest interest debt first is that if you have a lot of debt at a high interest rate, it can feel like it’s taking forever to see any results for your hard work in trying to get it paid off. This isn’t true for everyone of course, but there might be a chance that you’ll give up before reaching your debt free goal.
The debt snowball approach
With the debt snowball approach to paying off debt, you’ll be paying the smallest debt off first by throwing all the spare money you have at that one debt whilst paying the minimum payments on all the others. So for the example above, the order in which you’d be paying off your debt would look like this:
- Overdraft – £1K @ 19% EAR
- Car finance debt – £4K @ 5% APR
- Unsecured loan debt – £5K @ 4% APR
- Credit card debt – £10K @ 13% APR
Once the first debt has been paid off, you can use all your spare money plus whatever you were paying on the first debt to pay off the second debt in the list and so on until you have just one debt remaining which you’ll be paying off as fast as you can. Whilst doing this method, all the time you’ll be freeing up your money, leaving you with a better cashflow each month.
Dave Ramsey advocates and champions this method of paying off debt – he believes that psychologically, people are more inclined to succeed in paying off their debt if they can see results. By paying off the smallest debt first, you’ll be building that much needed momentum in actually getting some of your debts paid off quickly. From my own experience, I can honestly say that this approach worked for me much better than trying to pay off the highest interest rate debt first.
In summary
When you’re trying to pay off debt, the main goal is to do just that – pay off debt. The best way to pay off debt will depend on your ability and willpower to stick to the method you choose. Setting monthly goals once your debt payoff plan is underway will help to keep you motivated and stay the course in achieving your goal of debt freedom.
No matter which debt reduction method you choose though, try to make sure you’re paying the lowest amount of interest possible to begin with. I did a couple of balance transfers to 0% interest for my credit cards before I started with my own debt reduction plan. Watch out for those pesky balance transfer fees though – make sure you’ll be financially better off before going ahead with anything like this.
I hope you found this debt elimination tip useful! Make sure to subscribe to Disease Called Debt to make sure you don’t miss out on next week’s debt payoff tip!
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14 Comments
For me it would make the most sense to pay off the higher interest debt first. I don’t think the snowball method would work for me. Hopefully I will never be in a situation again where I have to pick a plan. 🙂
Tonya@Budget and the Beach recently posted…Simple Living and Saving Money
I’m doing kind of a combination of these two methods. Luckily, most of my highest interest debts are also the lower balance ones too… Love this series Hayley! 🙂
Kayla @ Shoeaholicnomore recently posted…October 2014 Results
Still think this series is awesome 🙂 I started with the snowball method and moved to the interest method when my biggest and unbudging loan was weighing too heavy on me. There is no way I would’ve been as motivated if I started with my biggest loan
Brittany recently posted…Weekend Survival Guide for the Girl on a Budget
I think we should add a third option to this the Debt Chunking method. I tend to be someone who gets very impatient with slow and steady and my two biggest debts have quite a bit of money to it. For me to see the progress go faster would be to pay regular payments, save any money that I had extra that I would pay toward debt, put that in a savings account and then when I reached a large chunk (a few thousand dollars or so) I would use that money to pay off a chunk of the debt. Now the downside to this is you need to save regularly, earmark that money for debt, and not be tempted to use it. But considering that paying down debt requires a lot of discipline anyway I think this method might work for some, particularly if you have large debts, instead of small ones. You certainly see progress anyway, but paying it off in larger chunks makes me feel like I have accomplished more. Thoughts?
Jason recently posted…Done With Debt By 45
I like that idea and completely agree that paying off a big chunk (even it means I saved for a few months) feels better than watching it go down slowly. I’m crossing my fingers that I end up over-saving (fat chance) for Christmas, and if I do, I’m going to try to take out a big chunk of the debt. Thanks for the idea!!
Brittany @ Fun on a Budget Blog recently posted…6 Ways to Conquer Wedding Planning
Efficiency of a plan is one thing; effectiveness of the plan is another. People can knock the debt snowball, but Dave Ramsey’s listeners get great results. It worked for us, too. We could have saved money by paying the highest interest first, but I believe we’d be taking on a additional risk of failure.
Good stuff!
Done by Forty recently posted…House Lust
Good advice. Before I even get my paycheck, I have already done my list of what to pay first. I start off with bills or debts that is nearly due so that IR wouldn’t incur. The interest method seems to be really good, for me.
Jayson @ Monster Piggy Bank recently posted…Online Business Update 2
I take a blended approach. The first debt I am targeting has the highest interest rate, just because the rate is so high. After that I will progress from smallest to largest.
Tre recently posted…401K. No Employer Match. What To Do?
I think the first method would be the best for me, but I’m a super dork and like to make charts and calculations to keep me motivated. I am see why the snowball would work best for some.
Femme @ femmefrugality recently posted…Free Tai Chi Sessions
I can see how the snowball/ladder would be motivating – and sometimes motivation can wane so I understand why people succeed with this approach. When I was a poor starving student – I did a variation of this. Instead of paying the minimum payment though – I would pay the minimum payment PLUS any accrued interest so that if felt like my “minimum” payments were making a dent. I have also said this a few times before – but I found it helpful to try and push through the next balance milestone – for example if my balance was $1060 – I would push to make sure the payment was $61 just to get under the $1000 level. All mental trickery but whatever works right?
May recently posted…Want to Buy a Snowmobile?
Great post! We did the debt snowball. It worked great for us! Our debts were $4k, $6K, and the big student loan at $38K. The student loan had the highest interest, so it would have been depressing to start there and not have any “wins” right away. We had enough in our savings to pay off the $4k immediately, so it was nice to start with a win. 🙂
Nichole @Budget Loving Military Wife recently posted…Have You Met the Breaking Point with Your Finances?
I think the debt snowball is pretty awesome. There are a lot of people who wouldn’t stick out their debt repayment if they were just trying to pay down a giant high interest debt. Instead, once they start seeing progress, it’s like building a debt payoff muscle and they’re more able to stick it out AND often they get so excited by the progress, they find even more ways to scrimp and save to add to their debt payments.
Mel recently posted…Financially Savvy Saturdays #63
Yes yes yes! Choose one. Whatever works for you. Just get it done!
Toni @ Debt Free Divas recently posted…Healthy Meals in a Hurry
I hear you! Thanks Toni!