When it comes to debt reduction, you want to be at the top of your game. There are many different ideas when it comes to debt reduction, but the best thing to do is think cool. You don't need a fancy strategy, and debt consolidation isn't necessary. Instead, there are 3 methods of debt reduction, subtly different from each other, that can help you reach your debt pay down goals.
For Debt Reduction, Think Snow
When you are ready to get rid of your debt, whether it's your Canadian credit card debt, or whether it's student loan debt, or any other obligation, all you need to do is think snow. You'll be able to stop debt cold, paying it off and finding your way to financial freedom.
There are three methods of debt reduction that involve snow as a metaphor for reducing debt:
- Debt Snowball
- Debt Avalanche
- Debt Snowflaking
All three of these methods involve planning if you expect to pay off your debt and see success in your finances. However, they are subtly different methods of paying off your debt. It's up to you to consider your emotional needs in paying off debt, and figuring out which method is likely to work best for you.
Debt Snowball
The debt snowball method has been popularized by U.S. personal finance guru Dave Ramsey. With this method, you list all of your debts, starting with the lowest balance and up through the highest balance. List out the minimum payments as well.
Next, decide how much extra you have each month to put toward your debt. Once you know this, you continue to pay the minimum balance on all of your debts. But, for the debt with the lowest balance, you put the extra toward it -- on top of the minimum balance. So, if you have $200 extra each month, and your first debt has a minimum payment of $25, you pay $225 on that debt.
Once your first debt is paid off, you take the entire amount, and apply it on top of your next debt's minimum payment. So, if your second debt has a minimum payment of $30, you will be paying $255 toward it. You continue to follow this pattern until your last debt is discharged. As you can see, your debt payments snowball until you are making bigger and bigger payments toward the end, and you retire your later debts even faster.
Debt Avalanche
The debt avalanche is similar to the debt snowball. It shares the same basic setup. However, instead of starting with the debt with the smallest balance, you order your debts by interest rate. You start with the highest interest rate (after accounting for tax deductions and credits) and pay that off first.
The point of the debt avalanche is that you actually pay less in interest over time, and you can even accelerate your debt pay off. However, the psychological impact makes a different. The debt snowball starts with the lowest balance first so that you have the satisfaction of retiring a debt quickly. You see results faster in many cases. With the debt avalanche, your success is a little longer in coming. Once it gets going, you see results, but initially, some people get discouraged and give up.
If you can work through the fact that it feels like you are putting too much in interest, and your first debt is reducing at a slower pace, the debt avalanche can work for you. You'll pay less in interest in the long run.
Debt Snowflaking
Debt snowflaking can help augment both the debt snowball and the debt avalanche. The point of debt snowflaking is to speed your debt pay down methods up quite a bit. Every extra dollar goes toward reducing debt. With this method, you start out with a debt snowball or a debt avalanche, and begin paying as normal.
However, there is a twist. Every time you get extra money, whether you save $1 with a coupon, or you earn $50 by selling something on eBay, you immediately apply it whatever balance you are currently working on. It may not sound like much, but it really starts to add up over time, and it can help reduce your principal.
Put together a debt reduction plan, and stick with it. You'll pay off your debt faster, save money.
This post was included in the Carnival of Personal Finance at One Cent At A Time.
Great piece!
Debt reduction is an important financial goal — and one of the most challenging. But if you take it step by step and keep at it, you can get on top of your debts, no matter how large. The best advice I continue to offer consumers over the years is:
1. Take Stock – note down how much you owe and to whom
2. Set debt priorities – categorize them as “good” debt or “bad” debt and you’ll start to see some obvious groups – higher interest rates vs. lower interest rates etc.
3. Boost payments – look at you budget and see what you may be able to give up without missing it and redirect those funds toward debt reduction. For example – rather than getting a newspaper service try reading online and the money you save from this can go toward debt reduction
4. Consolidate – if you have a number of high-interest debts consider consolidating. This will help you structure your payments and give you better cash flow and reduce the chance that payments are missed in error.
A good way to get started with the first step is to use online calculators like the debt management tool found here – https://www.tdcanadatrust.com/planning/debt.html