So far, we’ve discussed budgeting and tightening our belts. Now, it’s time to work on getting out of debt. There are a ton of different theories for paying off your debt and which debts to tackle first. Some say pay the one with with highest interest rate; some say pay the one with the smallest monthly payment. I’m in the camp with Larry Burkett and Dave Ramsey: I like to see results. Therefore, I’m a huge fan of the snowball method. Here’s how it works:
Say you have the following debts:
- Student loans – $10,000 ($250 per month @ 5.25%)
- Car loan – $9,500 ($350 per month @ 6.85%)
- Gas card – $300 balance ($30 per month @ 18.99%)
- Store credit card – $250 balance ($20 per month @ 21.99%)
- Visa card – $2500 balance ($60 per month @ 10.74%)
To make the minimum payments on these debts, you would need $710 a month. Does your situation look something like this? Here’s how we pay them off. First reorder the debt so the lowest balance is first.
- Store credit card
- Gas card
- Visa card
- Car loan
- Student loan
Now is the time to hunt for extra cash. Hold a tag sale, sell some stuff on ebay, work a few extra hours, or just cut back for a month (put those lattes away and make coffee at home). Say you can raise $200 from your efforts, plus you have an extra $30 a month to pay down your debt. Take the $250 ($200 from efforts plus $30 extra pay down plus your original $20 minimum payment) and put it toward the store credit card. One debt down, four to go. Now take your extra $30, plus the minimum payment from your store credit card and add that to the gas card. Now instead of paying $30 a month on the gas card, you are paying $80. See the snowball? In a few months you’ll have that card paid off and can add the $80 to the Visa card payment. Now, we are knocking down that debt.
Here is what I do personally. I have a monthly budget for debt payments. Each month my monthly payments drop because my balances are going down. It may be a few dollars on each minimum payment, but it helps add to the snowball. In this scenario, if my budget is $740 a month, I pay the minimum balance on all the debts except the one I am snowballing. The remaining balance goes to the lowest debt. As my minimum payments drop from making my payments each month, I have extra money to throw at the lowest balance.
This is a great way to free yourself from debt and it’s motivating because you see the progress. By spreading out your extra payments to all your debts or by paying extra on the highest balance, you will not get the instant gratification of knocking a balance to zero every few months. Let us know how you are doing with your debt. Shout out when you pay off a debt. It will help motivate all of us.