Paying Down Debt
Welcome back! It's May; hopefully, it is warmer wherever you live. Today, though, we'll be talking about snow :)
In my last post, we discussed different types of debt, enlightening us as to what debt to incur and what debt to focus on paying down. Spoiler alert: you want to get rid of revolving, unsecured debt. In this post, we'll focus on two different ways to pay down debt. Before we start, let's talk about why paying down debt is essential.
The importance of paying down debt might seem like a no-brainer. When you don't have debt, you don't owe anyone money, and you can do what you want with your money. Being able to do what you want with your money is the most important reason to pay down debt. Being debt-free increases your financial freedom and can increase your peace of mind.
Beyond personal reasons, there are economic ones to pay down debt, or a least keep your debt low, and that is the debt-to-income ratio. Debt-to-income ratio (DTI) divides your total monthly debt payments by your gross monthly income, providing you with a percentage. That percentage is used by lenders to determine whether or not to lend you money. Each lender has their own DTI requirements. DTI is only one factor in a lending decision, but it's an important one. In this article (also linked above), NerdWallet provides a calculator to understand your current DTI and an overview of what different DTIs mean for your level of debt.
Now that we've gotten the why out of the way, let's focus on the how. I'm sure there are many ways to pay down debt, but the two prevailing methods are debt snowball and debt avalanche. (I told you we'd be talking about snow!)
The debt snowball method has you pay off debt from smallest to largest. The name comes from a snowball rolling downhill and increasingly getting bigger as it collects more snow. The best way to utilize this method is to list your debts from the smallest amount owed to the largest amount owed. Continue to pay the minimum payment on all debts, but increase the payment on the smallest debt. For example, if your smallest debt is $400, and the minimum payment is $20/month, you might increase your monthly payment to $40/month to pay that debt off faster. Once you pay off the $400, you roll the $40/month payment into the next highest debt's monthly payment, increasing it by $40.
I have personal experience with the debt snowball method and can attest to its success. I used this to pay off ~$35,000 in student loans. I liked this method because I felt accomplished every time I paid off a smaller debt amount, and that motivated me to keep going until I paid everything off.
The debt avalanche method focuses on paying off the debt with the highest interest rates first, saving you money in the long run. You decrease the amount of money you pay in interest for that debt by focusing on the debt with the highest interest rate, This method is geared more toward the numbers-savvy and patient. Your highest-interest debt might also be the highest debt amount, and you will need staying power to pay it off without any early victory wins to motivate you.
Either one of these methods is a viable option for reducing your debt. Which is best for you depends on what you need to stay motivated and stick to the plan. Some people have even combined the two to reduce their debt.
Whether you choose snowball, avalanche, or a combination, the goal of debt repayment is to make monthly payments that exceed your minimum payment. And you can't do that without budgeting. Budgeting is the first step to paying down debt. It helps you understand how much surplus you have to work with to overpay on debt. It also allows you to see if you don't have a surplus, which prompts a different course of action: getting an additional or higher-paying job, asking for a raise, and reducing superfluous expenses, so you have the money to pay down your debt. If you haven't started budgeting, I recommend that as your first course of action for debt repayment. Choosing your debt repayment method comes right after that.
Paying down debt is about determination, not deprivation. Even as you increase your payments toward debt, don't forget to include 1-2 low-cost items in your budget that keep you mentally sane.
Now it's time to put on your ski pants and get ready to hit those debt-repayment slopes! We all know that après-ski (after paying down your debt) is when the real fun begins.