Okay, you’ve made some bad moves. You’ve found yourself using one (or more?) of the 10 excuses for going into debt and now you’ve seen the error of your ways and are committed to getting that debt monkey off your back.
Assuming you’re going to use the debt snowball method, which of the 3 different strategies should you use? What’s the wise move?
Pay off the smallest balances first.
With this strategy, you’re able to make a quick change to your situation, one that’s easy to see. You get to experience rapid successes by paying off company “A” then moving on to company “B.”. This is a good method for people who have a large number of debts, because once you pay off company “A” you’ll have a visible success and never have to think of that stinkin’ debt again.
Paying off 100 percent of any debt is extremely satisfying and will make you feel a sense of progress toward becoming debt-free. In addition, if you’re overwhelmed by the sheer quantity of payments you’re having to make every month, and all the accounts you have to maintain, you might like to go with this plan. I know from personal experience, that seeing the overall number shrink from 12 to 11 to 10 to 9, in a short period of time was very motivating. If you’re motivated by quick progress, this could be your most useful strategy.
Pay off the highest interest rate first.
This scenario makes the most sense from a pure dollars-and-cents approach. If you pay off those debts that cost you the most in interest, you get to keep more of your money over the long run. A credit card debt of $10,000 can potentially cost you $200 in interest every month.
Even if you have a credit card with a small balance and could pay it off immediately, if the interest rate is lower than your other debts, this strategy dictates that you work on the higher interest rate card first. By directing your excess cash to your highest interest rate debt, you’ll see your principal amount shrink faster and ultimately, you’ll save more money in interest.
Pay off the debt that will help your credit score the most.
If you’re planning to apply for a loan in the near future, how you pay down your debts could save you more than either the smallest payment or the interest rate approach. Credit scores look at a number of factors and one of them is, what percentage of a credit card’s limit is owed? If you owe more than 50 percent of the limit, you potentially lose credit score points. By paying down your balances so they’re all below 50 percent of the maximum will help your credit score and might save you some serious money on longer term loans.
In the end, its a personal choice and you have to pick the strategy that works best for you. Which strategy you choose isn’t nearly as important as actually choosing one and sticking with it. It’s like working out or dieting and your debt payoff plan has to satisfy you. You know your individual circumstances and you know best what will work for you. But make no mistake, paying off your debt is the right thing to do to avoid your own personal economic crisis, and as always, if you use the proper motivational strategy, along with a plan to make extra money, you’re well on your way to debt freedom!
[tags]debt, credit score, credit scores, credit scoring, debt strategy, how do I pay off my debt, how do I pay down debt, how do I pay off debt, how should I pay off debt, finance, money, finances, loan, loans[/tags]
photo credit: weegeebored
This post was included in The Carnival of Personal Finance #174 at Minding My Own Business. Thanks!
{ 3 trackbacks }
{ 3 comments }
My important tip… Once you get our of debt, STAY out of debt! You can’t just temporarily save money, change your lifestyle, or get a higher paying job. Keep your spending down, even when you are in no debt at all. That way you can start to save and be ready for the future.
Great article!
- Jack Rugile
Simple Sapien
One other strategy worth considering: list all debts by minimum payment, and pay them off in the order they would pay out first. In a “snowball” plan, this will free up “snowball” money faster and can often ultimately save money.
Good stuff, my friend.
My current plan is to pay off the highest interest debt…which also is the biggest amount. I agree though, that whatever plan you pick, you need to stick with it. Just because one plan seems to make more sense (on a purely numbers level), it might not be the best choice if you don’t actually do it!
Ron 's reply:
October 3rd, 2008
#Stephanie→
Great comment! It’s kinda like exercising. The best exercise is the one you actually DO!
Comments on this entry are closed.