You’ve probably been told, when it comes to debt, it’s best to avoid it altogether; and, if you happen to find yourself in debt, the best way to get rid of it is to pay it all off as quickly as possible.
While that approach makes sense mathematically, it’s definitely easier said than done.
According to a 2015 survey by The Pew Charitable Trust, 8 in 10 Americans have debt, with mortgage and credit card debt being the most common. The average mortgage balance was $130,000 in 2015, while the average credit card debt was $5,000. Auto debt averaged $14,000, while student loan debt added up to $20,000. You can see how easy it is to feel overwhelmed!
What do you do when you have debt and want to get rid of it, but aren’t quite sure how to tackle the problem? Here are two simple ways to consider paying off your debt.
Avalanche method: make a rational pay-off schedule
The avalanche method involves listing your debts from highest interest rate to lowest and making minimum payments on all debts except for the highest-rate debt. On that pricey balance, you’ll pay the minimum plus apply any extra money available. This method saves you the most money in the long run because you’ll pay off the most expensive debt soonest.
Let’s take a look at an example featuring monthly payments to four accounts:
|Credit Card ||Balance ||Interest Rate ||Minimum Payment |
|Card One ||$500 ||26% ||$50 |
|Card Two ||$2,500 ||18% ||$10 |
|Card Three ||$1,000 ||15.07% ||$40 |
|Card Four ||$1,000 ||12.82% ||$40 |
Using the avalanche method, you’d make the minimum payment on credit cards two, three and four. That amounts to $90. You would also pay $50 for credit card one ($140 total), plus any additional money leftover in your budget. If you had budgeted for $200 per month to pay off credit card debt, you’d be able to throw $110 at number one, thus reducing your balance to $390.
Let’s say you are able to apply $300 a month toward paying off the cards instead. The cards would be paid off in a little less than two years, and you would’ve paid a total of $849 in interest.