If you’re reading this article, you probably have some level of debt. Is it $5,000? $25,000? $100,000 or more? No matter the amount, my guess is that you’re looking for a system to rid yourself of this bad debt. Easier said than done. Do you ever feel as though you’re consistently making payments each month, but the balances barely move? Even when you pay extra on each loan or credit card, does it still feel like you’re not making a dent? We understand how you feel, and want to show you two different methods that can help you make real progress toward paying off that bad debt FOR GOOD. Once that bad debt is gone, you can begin your journey to financial freedom!
Let’s stop here for a minute. If you are serious about paying off your bad debt, then you need a comprehensive list of all your liabilities, as well as your current balances and interest rates. The best way to track your liabilities is to create your own personal Balance Sheet. If you need help doing this, we offer an online course called How to Create Your Personal Financial Statements that will walk you through it step-by-step, as well as provide blank templates to use for your own numbers. Once you have this comprehensive list, you now need to determine how much extra money you can devote to debt repayment each month. Avalanche & Snowball only work if you can dedicate more than the total minimum payments. Here’s an example. Add up all of your minimum payments, and let’s say that total is $1,000 per month. In order to have any chance at getting out of debt this century, you’ll need to find extra money to put toward debt repayment. It doesn’t have to be a lot, maybe 20% more. So in this example, find a way to come up with an extra $200 each month. After you decide on your number, you’re ready to choose the strategy that will work best for you!
This method focuses on paying off the debt with the highest interest rate first. The idea is to pay the minimum payment on all debt EXCEPT the one with the highest interest rate. That one gets all of your extra money for that month. Check out this visual:
So based on this example, your minimum payments are $1,000. But you have an extra $200 each month to put toward debt repayment! Using the Avalanche method, you put that toward Credit Card 1, to make that payment $350 each month. The enhanced payment each month will allow you to payoff that debt in just 27 months, saving time and money!
Then comes the magical part, take that $350 you were paying on card #1 and tackle the next highest interest rate. In this case that is card #2, and you will now be making a payment of $425 per month on that card. Since you were still paying the minimum for the previous 27 months, it should take ~6 months more to pay off that card too! Now you take that $425, add it to the $100 and tackle the HELOC with a total payment of $525. Note: We are never going above the $1,200 monthly total you allocated. It will take less another year to pay off the HELOC. Then guess what comes next? Add it to the student loan. While paying off the student loan, you get a bonus! Just by paying the minimum on your car each month, you will have that paid off in 5 years and can use that extra money to pay off the student loan even quicker! So now you’ll have ALL $1,200 going toward the student loan debt for the final 6 months.
To summarize, using the Avalanche method (and only adding an extra $200 per month) you paid off $67,000 worth of bad debt in roughly 5 ½ years!! That’s AMAZING!
This method focuses on paying off the debt with the lowest balance first, to get them out of the way before moving on to the bigger ones. The advantage of this model is that it helps build motivation for debt repayment as you start to see some balances go to $0 quicker. Some people need to see those quick wins in order to stick to their strategy.
So using this model on our debt example chart from above, you would tackle your debts in this order: Credit card #2, HELOC, credit card #1, car, and finally student loan. Remember, you still use the $1,200 total per month, so tackling credit card #2 would be a $275 monthly payment. Similar to the Avalanche method, you should take the payment used to service any completed debt, and add it to the payment for the next debt you’re going to tackle, and so on. Hence, the snowball effect! Here are some of the biggest differences between the two methods.
Time until paying off first debt: Avalanche ~27 months; Snowball ~16 months
Time to pay off all bad debt: Avalanche ~5 ½ years; Snowball ~5 ¾ years
Total interest paid: ~$2,500 more on the Snowball method
To summarize, using the Snowball method (and only adding an extra $200 per month) you paid off $67,000 worth of bad debt in roughly 5 ¾ years!! That’s also AMAZING!
Here is what we learned:
1. Both methods are similar in their effectiveness and ability to pay down bad debt.
2. The Snowball method may be better for people who want to see those quick wins to stay motivated and on track.
3. The Avalanche method will save a little time and money if you’re disciplined and patient enough to stay the course.
4. If you would have just paid the minimums (using either method), it would have taken roughly 2 years longer and an extra $7,000 in interest. Moral of the story…find some extra money each month, it makes a HUGE difference
5. Regardless of which method you choose, you’ll need to determine your monthly minimums, your balances, and figure out how to devote some extra cash toward debt repayment.
6. This ONLY works if you don’t add any more new debt to your total, so stop using those credit cards!
7. Once you are free of bad debt, take all those monthly payments and use them to purchase cash flowing assets. That will move you down the path toward financial freedom!
So collect all your personal numbers, determine your preferred strategy, and get to it! Before you know it, you’ll be making your FINAL bad debt payment!
*Minimum payments, balances, interest rates, and extra repayment amount used are for example purposes only. Your personal numbers may be more or less, which could increase or decrease the amount of time necessary to payoff.