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If you read a lot of personal finance blogs about consumer debt, you know they are filled with discussions of snowballs and avalanches. If you didn’t know better, you might think cold temperatures and steep alpine slopes had more to do with repaying consumer debts than any human effort at all. To muddy the waters (or disturb the snowy mountainsides), let’s add two more descriptions to the mix: the debt landslide and the debt cascade.
What is the best way to get out of debt?
The best way to get out of consumer debt is to choose a method that matches both your goals and your personality. Some approaches save money and time while others build credit or personal motivation. Each approach works best for consumers whose personality best fits the approach’s requirements.
Keys to Every Debt Repayment Approach
Regardless of the method you choose to follow below in your efforts to pay off your debts, there are several key principles everyone needs to follow in order to accelerate their debt elimination.
First, there is no way around it. You must find a way to send more than the minimum payment requested by the lender. Without it, there is no acceleration of debt repayment at all. Sending payment above and beyond the required amount can dramatically cut the time you need to become debt-free, even without additional steps.
Loading your payments is the process of moving your monthly payments from one debt to another each time you pay off an account in full. Also known as rolling over your payments, loading is critical to your debt repayment acceleration plan.
Imagine that each debt is a train pulling into the station and that the passengers represent the money you have to pay the lender. Each time you pay off a train, it no longer pulls into the station. Instead, you load the next train with all the passengers who were getting on the paid off train plus those who were waiting for the income train already. You may double the amount of payment you make to the second debt. Yes, the train is crowded, but pretty soon, you will pay that debt off and load its payments onto the next train you focus on.
Loading your debt payments in this way ensures that you accelerate your debt freedom day with all of your creditors and not just one or two.
Negotiating Lower Interest Rates
By calling your creditors to ask for a lower interest rate, you may just be able to get more of your monthly payment to go toward bringing down your account’s balance rather than to interest.
Even if it is just a percentage point or two, you might just complete your debt repayment plan a month or two or twelve early. And an early repayment means more money in your pocket.
1. Debt Avalanche Approach
Long a favorite of the CPA and financial advisor crowd, the Debt Avalanche gained its name relatively recently. As the approach that saves consumers the most interest and time throughout the repayment process, the avalanche well deserves the praise it receives from financial professionals.
How it Works
Send the extra payments mentioned above to your account with the highest interest rate first. In the meantime, send minimum payments to all other accounts. Each time an account is paid in full, load its previous monthly payment onto your account with the highest interest rate first.
There is no disputing the Avalanche is the heavyweight king of debt elimination. It will save you more in interest and have you debt free earlier than any other debt repayment approach, period. No question. Anyone who says otherwise is selling something, including their image as an expert.
It is true that focusing on your account with the highest interest rate first can mean that it will take a year or two or more before you repay any account.
Such a long period between your start and the first debt repaid can lead to discouragement in many consumers.
Whom the Avalanche Is for
This approach requires self-discipline and self-confidence. You must be persistent in your focus to pay off your debts.
Is it any wonder that CPAs (often the model of self-restraint and discipline) prefer and promote this method?
2. Debt Snowball Approach
Made popular by a national talk radio host, the Snowball has a near fanatical following across the country, so much so that adherents find it difficult to believe (or even consider) that another approach might work at all for them, let along better.
How it Works
The Debt Snowball approach recommends that you send your extra payment to your account with the lowest balance.
By focusing on the smallest balance first, you will typically get an “early win” in your fight against debt. If you have a small retail store card, for example, with just a $50 balance that you have been making minimum payments on for years, getting that paid off in a hurry can result in a big moral victory, boosting your morale and providing the motivation you might need to keep at your debt elimination plan.
Besides the fact that you will pay more interest over time using this approach than the Debt Avalanche, the Debt Snowball will also take you longer to achieve your goal of debt freedom.
In most cases, it may only take an extra two or three months, but during those two or three months, you are sending a large amount of money to your creditors that you would not have to send had you used a different approach.
Whom the Snowball Is for
The Debt Snowball has its appropriate application. If you have tried repaying your debts before without success, especially because you have become discouraged by how long it takes to see progress, the Snowball might be right for you.
However, instead of sticking with the snowball for the entire duration of your debt elimination plan, use it to get rid of your first debt, or maybe even your first two debts. Once you see you are making progress toward your debt freedom goal by paying off one or two accounts, you will likely be ready to move from the Snowball to the Avalanche.
3. Debt Landslide Approach
Having identified and named the Debt Landslide, I can tell you that it has its rightful place among the pantheon of do-it-yourself debt elimination approaches, but it is not for everybody.
How it Works
The Debt Landslide recommends that you send your extra payments each month to the newest account among your debts in order to improve your credit rating faster.
FICO and other credit scoring models weigh activity on newer accounts more than they do activity on older accounts. That means that by paying down your newer accounts, you can generally rebuild your credit rating faster than if you focused on older accounts.
Like the Debt Snowball, the Debt Landslide will have you pay more in interest than the Avalanche over time because you are not focusing on your debts with the highest interest rates first.
Whom the Landslide Is for
If you are considering the purchase of a home using a mortgage in the next year or two, or if you are considering another major purchase on credit in the near future (e.g. small business or start up), you might consider the Debt Landslide to accelerate both your debt elimination and your credit building goals simultaneously.
4. Debt Cascade Approach
As the final do-it-yourself debt elimination approach, the Debt Cascade offers an accelerated option even for individuals who feel broke or otherwise feel they have no “extra” cash to send to their debts.
How it Works
Instead of sending an additional payment each month, the Cascade recommends that you fix in place your current monthly payments so that next month, when your creditors request smaller minimum payments, you still send them this month’s amounts. The next month, your creditors will request even smaller payments, but you will continue to send this month’s larger payments.
Initially, the difference between your “fixed” payment and the creditors’ newest minimum required payments may be just a dollar or two. Within five or six months, though, the difference could amount to $20 to $50 to even $100.
At that point, you should consider switching to the Debt Avalanche or Landslide method, based upon your goals, using the difference between your fixed payment and the creditors’ requested payments as your monthly “extra” payment.
The Cascade allows you to accelerate your debt elimination plan even if you have no additional or available cash to make extra payments. Instead of a 15- to 25-year repayment term making minimum payments, the Debt Cascade approach can have you out of debt in just five and a half years or so. Additionally, the Cascade can cut the total amount of interest you pay nearly in half when compared to the minimum payment method.
You will still be paying more interest over time using this method than any of the other methods. Additionally, you may be so tempted to disregard the small difference between your fixed payment and the minimum monthly payments early on that you disregard the impact the Landslide can have, leading you to ignore the approach altogether.
Whom the Cascade Is for
Anyone truly struggling to come up with an extra $25 or more to send off to their creditors in addition to the required minimum payments will benefit from the Debt Cascade approach.
Get Out of Debt – Related Questions
Which debt should you pay off first? To save the most in interest paid, pay off the highest interest account first. To build the most momentum, pay off the lowest balance first. To rebuild your credit fastest, pay off your newest account first.
Is it better to put money into savings or pay off debt? You should not consider this an either/or question. If you have consumer debts, you should use most of your discretionary money to accelerate your debt repayment. However, you should also commit to saving even $5 or $10 a month during your debt repayment plan.