Less Stress Debt Repayments—The Snowball Method
One of the big problems people have with their finances is that they don’t attack their debt. Instead, they slowly pay bits and pieces off and then get very frustrated and lost in the whole process. So, you need to have a strategy.
There are two main strategies to remove debt, but they both have something in common.
What is it?
Both methods involve isolating one piece of debt at a time and removing it.
Put all your energy (and as much money as you can) into paying off one credit card, loan, or another kind of debt.
Why should you concentrate on just one debt instead of paying down all of them?
When that first loan gets paid off, then you’re no longer paying interest on any outstanding.
Then you can use all that energy to pay off the next one. I call it a snowball effect.
Let’s say you have four pieces of debt: you have two credit cards, a personal loan, and a car loan.
You decide that you need to pay off credit card number one. Once you pay it off, you cut it up and move on to credit card number two.
The snowball happens because as each debt goes down, you’re no longer paying the interest charge and credit card fees for the debt you have paid off completely. So then you can apply that extra money to the next credit card or loan, then the next…
By the time you get to that last piece of debt, you’re able to pour a lot more energy and money into that debt than you were on the first.
It’s compound interest in reverse.
People are shocked by how well this works. First, you spend a lot of energy on the first couple of debts, then the momentum builds, and it’s easier and quicker to pay off the others.
What are the two methods to pay down your debt?
The first method is the highest interest method. The second is the lowest outstanding debt method.
Both methods require you to take a complete inventory.
List all your inventory of outstanding debt. Then next to each debt, write down both the outstanding amount and the outstanding interest charge.
Interestingly, you’ll probably find the outstanding amount (what you owe in dollars) very easily, but the interest charge can be a lot harder to find.
They do that for a reason.
It’s usually challenging to determine how much you’re being charged in interest. So be prepared to do some fine print reading.
When you finally find it, you’ll probably have to pick yourself up off the floor because it’s so expensive.
It’s incredibly expensive to have credit card debt.
So, how can you tackle that debt?
The high-interest method.
Let’s talk about the high-interest method first.
For the high-interest method, you need to look at your list and arrange each piece of debt from highest interest rate to lowest.
Maybe the interest rates look like this: one’s at 17%, one’s at 22%, one’s at 11% and one’s at 8%. So, you list each debt as:
- $ amount – 22%
- $ amount – 17%
- $ amount – 11%
- $ amount – 8%
You’re going to attack the highest interest first.
In this case, the 22% is the one that you’re going to pay first. Then you’ll attack the 17% next, then the 11%, then the 8%.
The second method is the lowest outstanding debt.
Lowest debt method.
The lowest debt method is an interesting method.
Maybe you have a small debt of just a couple hundred dollars, and you have another one that’s maybe $5000. And perhaps the debt that’s the lowest dollar amount also has the lowest interest rate.
So, with the first method, you would be paying this one last.
Why would you want to pay it first?
Because it gets one debt out of the way quickly, which is a huge psychological boost.
Once you pay off the first debt, you’ll feel great. You’re making progress. You get that psychological momentum, which is incredibly important.
So, this method snowballs that way—with psychological motivation.
Once you’ve paid off the lowest balance, then go to the second-lowest balance, and so on.
Which method is better?
Mathematically the best approach is the highest interest.
Paying off the higher interest rate debts will get you debt-free quicker. But you can use either approach.
It all depends on your makeup, the way you feel, and the motivation and sense of achievement you need to continue the task.
We’re not calculators; we’re human beings. We all need that boost, some more than others, and that’s okay.
Most people have more success by paying off the lowest outstanding debt first—it just takes them a bit longer than if they used the highest interest first method.
No matter which option you choose, it’s a hard road, and every little bit of help is a great benefit.
So, choose whichever method you think will be the most successful for you.
What if the loans are all similar?
There are instances where the outstanding amounts are very close, but the interest rates are very disparate.
So, maybe you’ve got an interest rate of 22% on a $600 debt, and you have an 8% on a $500 debt. Which method do you use?
In that case, the amount is very close to each other, so go straight to the highest interest.
Default to the highest interest method if the outstanding debt is not that large and you have various debts of around the same amount.
But both processes are enormously effective. So, go ahead and pay off those debts!
To pay off debts without the stress, remember…
- To pay off your debt, you need a strategy—paying bits and pieces off won’t get you out of debt.
- Write a list of your debts, including the amounts and interest rates.
- If you need fast motivation, pay off the smallest debts first, and work your way up—this will give you the psychological boost you need to keep going.
- To pay off debt more quickly, pay the highest interest rate debts first.
- Use the money you were paying toward the last debt to pay off the next one, slowly adding more as your overall fees and interest rates reduce—this is the snowball effect.
- If you have debts that are around the same amount, pay the highest interest ones first.
For professional money management help, contact TWSG team today.
This information has been provided as general advice. We have not considered your financial circumstances, needs or objectives. You should consider the appropriateness of the advice. You should obtain and consider the relevant Product Disclosure Statement (PDS) and seek the assistance of an authorised financial adviser before making any decision regarding any products or strategies mentioned in this communication.
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Who is Paul Atherton, That Wall Street Guy?
An ex-Wall Street advisor who worked with major players in the global financial industry for over 30 years, Paul’s mission is to help regular people reclaim their wealth and financial security.
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