- Education
Different Strategies to Payoff Your Debt
Natalie Tuchscherer
SVP | Mortgage Lender
In American society debt has become very common. Debt can be strategically utilized and beneficial for most Americans. For example, taking out a loan to purchase a $300,000 house gets you into a house much quicker than trying to save $300,000. However, debt has morphed into a large financial burden for most people. When starting to tackle your debt, it can be very intimidating. However, there are a few different strategies that you can utilize to pay off your debt! The two most common debt payoff styles are the Snowball Method and the Avalanche Method.
Snowball Method
The Snowball Method begins by paying off your smallest debt first. Start by listing all your debts from the smallest to largest dollar amount. You will make minimum payments of all of your outstanding debt, but the item that has the smallest dollar amount, you will make an extra monthly payment towards that loan to pay it off sooner. Once that loan is paid off, you will take the minimum payment for that loan plus the extra payment and apply it to the next loan.
Snowball Method Example:
- Debt One: $500.00 loan with $50.00 monthly payment.
- Debt Two: $1,000.00 loan with $50.00 monthly payment.
- Debt Three: $2,000.00 loan with $50.00 monthly payment.
Put an additional monthly payment towards debt one and once that loan is paid off you will take that payment amount (minimum + extra) and put it towards your second lowest balance (debt two). Repeat this until all your loans are paid off moving from the lowest balance to the highest.
This method is based on the reward response in your brain. When a task is completed and you get a quick reward, you are more likely to stick with it. That being said, in the long run, you may not save as much.
Avalanche Method
The Avalanche Method is based on paying off the loan with the highest interest rate first. Start by listing all your debts in order of highest to lowest interest rate. You would, pay the minimum monthly payment but make extra payments towards the loan with the highest interest rate. Once you have paid that off, you would then use the extra funds to pay off the next loan with the second highest interest rate.
Avalanche Method Example:
- Debt One: $2,000.00 loan with $50.00 monthly payment and 20% interest.
- Debt Two: $1,000.00 loan with $50.00 monthly payment 15% interest.
- Debt Three: $500.00 loan with $50.00 monthly payment 10% interest.
Put an additional monthly payment towards debt one and once that loan is paid off you will take that payment amount (minimum + extra) and put it towards your second highest interest rate (debt two). Repeat this until all your loans are paid off moving from the highest to lowest interest rate.
This method is focused on saving the most money because you are targeting the debt with the highest interest rate. The item with the highest interest rate could also be the item with the highest dollar amount, so it may take longer to payoff that first debt.
Both methods work great for paying off loans, however, you need to decide which method will allow you to be successful.
If you are the type of person that likes to see items checked off your list quickly, then the Snowball Method may be right for you. If you can see the long-term benefit and are able to stick to paying off larger debts first, then the Avalanche Method may be right for you.
Becoming debt free is attainable no matter what your income level is, it just requires a little discipline!