If you are looking to pay off debt, it is not enough simply to desire the outcome. There must be a series of actions to take over a defined period of time to make it happen. It requires submitting yourself to a process, a willingness to say no to some things, and the discipline to follow through on what you aim for.
There are a number of plans that can help you pay off debt. I have come across three effective ones. Now, being a Ramsey Preferred Coach, I tend to prefer one of them. Not just because it’s the method advocated for by Dave Ramsey, but because the data show it to be the most effective.
Nonetheless, there are other ways to pay off debt that will allow you some flexibility in putting things into action. Without further ado, let’s take a look at these three plans.
The Debt Snowball is a highly effective way to pay off debt. This is a plan that, at first glance, looks like mathematical blasphemy. And that’s probably true.
But personal finance is far more than just math. I say it’s mostly behavior, with a minority portion attributable to the math.
Here’s how the debt snowball works: List your non-mortgage debts in order from smallest to largest. Disregard the type of debt, interest rate, secured versus unsecured, etc. Simply lay them out from smallest balance to largest balance.
When you’ve laid them out, put everything on minimum payments only. With what is left over in your monthly budget, use all of your extra earnings to attack the smallest debt with a vengeance.
Once you have paid off the smallest debt, roll that large payment into the next smallest debt. Make the minimums on all other debts and attack the second-smallest debt with a vengeance until it is paid.
You continue doing this with each debt in your name until all debts are gone.
Let’s consider an example. You have three debts; one for $2,000, a second for $3,000, and the other for $5,000. That’s a total of $10,000.
The minimum monthly payments for the debts are, respectively, $200, $300, and $500. The debt snowball teaches making only the $300 and $500 monthly payments on debts 2 and 3 while making $200 plus any extra that is available in the budget. Once you pay off debt 1, then move on to debt 2, and then debt 3.
The main idea behind the Debt Snowball is building momentum. You can achieve victories early on that will carry you through the larger debts that take longer to pay off.
The next plan to pay off debt is the Debt Avalanche. This plan focuses more on interest rates than on amounts owed. So, technically, it is more mathematically sound for the math nerds out there.
This plan has you paying off the debts with the highest interest rates first. You list your debts in order from smallest to largest interest rate, and then attack them in order from largest interest rate to smallest.
The idea is that you reduce the amount paid in interest over time. Interest alone can compound quickly, especially with certain types of debt like student loans and credit cards. So for those looking to reduce interest paid, this is a viable plan to pay off debt.
Let’s say the above mentioned debts ($2,000, $3,000, and $5,000) have interest rates of 5%, 15%, and 10%, respectively. With the Debt Avalanche, you would pay off debt 2 first, since it has the highest interest rate.
Once debt 2 is paid off, the next debt would be number 3. After that one is paid off, then number 1 would be last.
This plan looks most appealing in terms of raw interest savings. But there may be downsides to handling it this way. If your biggest debts have the highest interest rate, it can take a long time to pay off even one debt.
If that’s the case, it is easy to become demoralized and lose motivation to keep pushing forward. So if you choose the Debt Avalanche method, keep your long-term goals in mind every single day and remember why you are doing this.
The Debt Tsunami plan to pay off debt stands apart from both the Debt Snowball and the Debt Avalanche. While the other two plans focus on certain numerical aspects, and some psychological (with the Snowball), the Debt Tsunami focuses entirely on the emotional impact your debts have on you.
With this plan to pay off debt, you attack the one that weighs on you the heaviest. This plan disregards balance, monthly payment amount, and interest rate.
Let’s continue with our example. The three debts above are all different amounts. But for the Debt Tsunami, we’re going to focus on which weighs most heavily. The $5,000 balance is the highest. But let’s say the $3,000 is from your supervisor at work, and there is a really weird dynamic going on.
A credit card company is not constantly interacting with you (at least, we hope not). But your supervisor at work has the employment authority dynamic going on. Adding the master-servant dynamic of being in debt to him or her, and you’ve got a recipe for some weirdness.
The Debt Tsunami has you paying off this debt first if it has the most emotional weight. You ignore the math of the situation and rid yourself of the baggage. Sometimes being rid of something that clouds your judgment and vision can be worth temporarily ignoring the math of the equation.
I had a client use this method a few years ago. This was their third or fourth-largest debt. They wanted to follow the Debt Snowball, but this personal loan was a major drain on this couple’s well-being. I asked them about paying it off first, then hopping into the Debt Snowball.
They agreed, and paid off $40,000 in about one year. It worked in this situation, but may not be right for everyone. Plus, we don’t want to make our decisions based on emotion. Yes, we need to recognize them and figure out why we feel a certain way. But fleeting feelings will not guide us into wise and sustainable financial paths.
What’s the Best Plan to Pay off Debt?
Like I said before, I have a preference, and that’s the Debt Snowball. The data show that this method, using a concentrated payoff plan, tends to increase motivation, as there are visible victories along the way. Not to mention our own story, and the many victories shared by my clients using this plan.
It’s true that the Debt Snowball looks like it will lead to more interest payments over time. But that assertion is based on the assumption that you will fully follow through on a certain plan.
The Debt Avalanche method looks best in terms of interest saved. But if you fall off the wagon and don’t continue with your plan, there won’t be interest saved because you didn’t finish the job!
And for the Debt Tsunami method, it won’t help if all of your debt-free plans are based on your emotions. Our feelings are fleeting and we rely on them at our peril.
To make any plan work, you have to actually see it through. Doing something halfway is no way to do things. That’s especially true in personal finance.
What it boils down to is this: find the plan that resonates best with you, and do it diligently. This requires thinking and self-reflection. It requires self-discipline and perseverance.
But, to me, there’s no other acceptable option. Mediocre is not acceptable to me. I am going to aim for excellence in everything I do. And I hope you will aspire to do the same.
If you need help with your plans to pay off debt, let’s talk. Schedule your free Discovery Session today to learn how I can guide you in the habits and mentalities that lead to wealth and financial freedom.