If you’re like most people, you’ve got some form of debt. It could be a car loan, it could be credit cards, or it could be “good debt” like student loans.
No matter, it’s got to go. You need to get out of debt if you’re ever going to build any kind of wealth. Seriously. The money that’s going toward your debt is the same money that will go toward wealth.
And you want to be wealthy right? Or at least wealthy enough to have choices and to feel secure?
Then it’s time to get focused.
However, your immediate roadblock is figuring out what to focus on. After all, you probably have debt from more than one place.
There are two primary methods to paying off debt: focusing on the debt with the lowest interest rate first, versus focusing on the debt with the smallest debt amount first.
The latter, called the debt snowball, is by far the method I favor. Increased simplicity and more visible progress are the main reasons.
The other method (which doesn’t have as snazzy a name), will enable you to pay off your debts slightly faster, so you’ll save a little bit of money.
I’ve talked about how this works out in practice, but I want to revisit it, not because my views have changed, but because it’s so important.
The debate about smallest debt versus smallest interest rate will rage forever, like a Beatles/Stones debate or a Coke/Pepsi debate.
(My answers: Beatles, La Croix.)
But hidden in those debates is a reality that people don’t acknowledge: you don’t need to pick one or the other! No one is forcing you to only listen to The Beatles, or drink Coke, for the rest of your life.
So too is your debt strategy.
Here’s an example. Let’s say you have the following debts:
a) Student loans: $40,000 @ 6%
b) Credit card: $6,000 @ 12%
c) Car: $5,000 @ 4%
The debt snowball will say that you pay off c) the car loan first, paying the minimums on everything else, then pay off b) the credit card, and then a) the student loan.
The other method says pay off b) the credit card first, then a) the student loan, then c) the car.
Personally, I think both strategies have some downsides.
The problem with the debt snowball is that the difference in balance between the car loan and the credit cards is so small, while the difference in interest rate is so great. I’d go for the credit card first over the car. Yes, it’ll take fractionally longer, but it’s a bigger win.
The problem with the other method is that you’ll have your car loan pretty much forever. Pay off $40,000 in student loans before your measly car? What a waste of payments. I’d get rid of the car before tackling the student loans.
So you see, in this case, neither method feels optimal. I’d pay off b) the credit card, then c) the car, then a) the student loans.
Focus on one
What do these two methods of paying off debt have in common?
They both recommend you focus on one debt at a time.
I know of no recommended method that advocates “paying a little extra on everything”. I’ll call that the “debt burnout” method, because that’s what you’ll do.
So frankly, as long as you focus on one of your debts, any one of your debts, you’re on your way to getting rid of them, and moving on with your life.
Latest posts by Mike Pumphrey (see all)
- Can you use an HSA to save for retirement? - October 19, 2017
- The investment hat trick: The health savings account (HSA) - October 16, 2017
- This is why I don’t pick stocks - October 12, 2017