Carrying a big load of debt can have serious consequences. I will not only take a toll on you emotionally it can actually harm you physically. Research has shown that the stress related to debt can cause stomach problems, arthritis, high blood pressure, a spastic colon, bladder infections, fibromyalgia, asthma, headaches, and even heart disease. Fortunately, there are two proven methods for repaying debt. Choose one of the two and you could quickly be on your way to not only becoming debt-free but also getting rid of all that the physical and emotional stress caused by your debts.
The avalanche method of debt repayment
If you choose the avalanche method for repaying your debts you will need to make a list of all of them – credit card debts, loans, student loans, everything – and then put them in order with the one that has the highest interest rate down to the one with the lowest. You then focus your efforts on paying off your debts in that order. This means first focusing all of your attention on the debt with the highest interest rate. Of course, you will need to continue making at least the minimum payments on your other debts. Why do some experts like the avalanche method? It’s because if you get rid of your most costly debts first you will save the most money.
The snowball method of debt repayment
This method of debt repayment was pioneered by the financial expert Dave Ramsey. It requires you to list all of your debts with the one that has the lowest balance at the top down to the one with the highest balance. You then focus all of your efforts on paying off that debt with the lowest balance – while continuing to make the minimum payments on your other debts.
Here’s an example of how this works. Let’s suppose you have the following debts:
- Credit card debt A: $500, minimum payment $25
- Credit card debt B: $1200, minimum payment $35
- Department store credit card: $1800, minimum payment $42
- Student debt: $5100, minimum payment $105
If you first pay off credit card debt A you will have an extra $25 plus the $35 minimum payment on credit card B to pay on that debt. Once you have it paid off you will have the $25 from credit card debt A, the $35 from credit card debt B and the $42 minimum payment on the department store credit card – for a total of $102 to pay on that department store debt. This means you should have it totally paid off in about 14 months and can then go to work on that student loan debt.
Why it’s called the snowball method
This is called the snowball method of debt repayment because the philosophy behind it is that every time you pay off one of your debts you’ll develop increased momentum to begin paying off the next one just as a snowball picks up speed as it rolls downhill.
Both of these methods can help you get your debts under control and paid off. So, should you choose the avalanche or snowball method? To pick one of the two you need to first understand your own personality. The bottom line is the one that you choose has to be a good fit. For example, the debt snowball method takes into account the behavioral and emotional aspects of personal finances. As you knock out that debt with the lowest balance it may be easier for you to stay on track because you got to a quick “win”. It does take hard work to pay off a large amount of debt and the debt snowball method could help you stick to your plan so you don’t get frustrated and overwhelmed by the process as you see you’re actually making progress
The debt avalanche method is better strictly from a mathematical point of view because it requires you to focus on the debt with the highest interest rate and pay no attention to its balance. Where the mathematics come in is that the debt avalanche method will save you the most money over the long term. However, if your debt with the highest interest rate comes with a bigger balance than some of your other debts keep in mind it will take you much longer to repay that debt. In other words, the debt avalanche method would not be a good choice if you’re the kind of person that requires fast results. On the other hand, if you’re high on self-discipline and don’t have a big need for instant gratification then the avalanche method of debt payment might be a better choice.
A debt consolidation loan
If you feel utterly swamped by your debt, then a better alternative might be to get a debt consolidation loan. If most of your debt is high interest credit card debt you might be able to transfer those balances to a 0% interest balance transfer card. There are cards available now that will give you as many as 22 months’ interest free. That might be enough time for you to actually pay off your balance before the interest charge kicks in.
If you have different types of debts like those listed earlier in this article a better option might be to get a debt consolidation loan. If you have equity in your home, you can get a home equity loan or homeowner equity line of credit. In mid January of this year the national average interest rate was about 5% for a $30,000 fixed-interest home equity loan. And in February you could get a 30,000 HELOC at an average interest rate of 5.2%. Add up the interest rates on your debts, divide this by the number of your debts and the odds are you’ll find your average interest rate is much higher than even the 5.2%. If you don’t own your own home but have good credit you should be able to get a personal loan and maybe for 10% APR. And that, too, should be much better than the average interest rate you’re paying on your debts now.
Trading money for time
A debt consolidation loan can be a good solution but it’s important to understand you would be trading money for time. In other words, you will have much lower monthly payments but the odds are your loan will have a much longer term, so you will actually end up paying more interest over the long-term.