Perhaps you stay awake at night feeling the weight of too much debt. Maybe you’re afraid to answer the phone because it might be a creditor calling. Or perhaps you simply don’t feel like you can ever get ahead because all your money is going to pay interest on your debt.
Simply having a plan to chip away at that mountain of debt can bring stress relief and a peace of mind. Let’s talk about that plan!
Know what debt you have
Make a list of all the debt you have. The list should include who you owe, the amount you owe, the minimum monthly payment required, and the interest rate you are being charged. Then sort the list (re-write it if you need to) by smallest amount owed first to the largest amount owed last. Good news! You have identified your “debt mountain.” Without this critical first step you can’t put a plan in place.
Start chipping away at the mountain
Now that you’ve identified the mountain let’s put a plan in place to get rid of it! It’s important to realize this mountain won’t just disappear but don’t lose hope. You can chip away at it over time. There are two schools of thought on how to do this. Let me explain them both and then make a recommendation.
Get that debt snow ball rolling
An effective plan is to gain some positive momentum. You do this by throwing as much money at the smallest amount owed while making only the minimum required payment on all the other balances. This assumes you can make more than the minimum required on this smallest amount. If you can’t, then you need to re-do your budget by cutting some expenses somewhere else, or by increasing your income.
Once you payoff this smallest balance you immediately move to the next smallest balance. So, if you had been paying $50/month toward that smallest balance that you just paid off and $30/month toward the second smallest, you should now be paying $80/month toward that new smallest balance. The amount you’re paying toward your debt hasn’t changed but now you have one less balance, one less creditor. Congratulations!
You continue doing this until you have paid off all of your debt. It will be easiest to pay-off the smallest balance, so by doing so first, you will gain some momentum just like a snowball rolling down a hill.
Another method would be to tackle the debt balance with the highest interest rate first. After all, this is the balance that is costing you the most money over time. Which of course is true and the positive part of tackling the highest rate first. The downside of this, is that because it’s the largest balance, it will also take the longest time to pay-off. Many people may become discouraged and give-up before it’s accomplished.
My recommendation is to tackle the smallest outstanding balance first, then the next smallest etc. until you are debt free.
There are some exceptions to think about
Here are a couple of simple things to think about as you put your debt snow ball plan together. First, if two of your balances are similar in size but not in rate, then flip these to tackle the highest rate first. For example, you owe $900 at 5% and $1,000 at 15%. A strict following of the debt snow ball method would have you tackling the $900 balance first. Given that these two balances are very similar in size but the $1,000 balance is a lot more costly, I would tackle the $1,000 balance first.
Second, if you do not have any emergency savings, I would just pay the minimum balance on my debt until you have established a $500-$1,000 emergency savings fund. But do this quickly so you can start tackling that debt using the snow ball method.
You can do this!
See https://www.daveramsey.com/blog/get-out-of-debt-with-the-debt-snowball-plan/ for more information on the debt snow ball method