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Debt and debt repayment
When you need to pay off debt, you have a few options. You can pay off the debt with the highest interest rate first, or you can pay off the smallest debt first. Each method has its pros and cons, so it's important to choose the one that will work best for you.
Paying debt off
Sometimes, you might find yourself with more debt than you can handle. There are several ways to help you pay off the debt, and two of the most popular methods are the snowball method and the high rate method. Let's explore both of these methods to understand how they can help you become debt-free.
The snowball method
Imagine you have a snowball, and as you roll it around in the snow, it gets bigger and bigger. This is similar to how the snowball method works for paying off debt.
In this method, you start by focusing on your smallest debt first. You pay as much as you can on this small debt while making the minimum payments on your other debts. Once you've paid off the smallest debt, you move on to the next smallest, and so on, until all your debts are paid off.
Let's say you have three debts:
- A car loan with a balance of
- A credit card with a balance of
- A student loan with a balance of
If you are following the snowball method, you will arrange your debts from the smallest balance to the biggest one, like this:
| Balance | Type of loan | Interest rate |
|---|---|---|
| Credit card | ||
| Student loan | ||
| Car loan |
Using the snowball method, you'd start by putting extra money toward the credit card debt. Once that's paid off, you'd move on to the student loan, and finally, the car loan.
This method can make you feel good because you'll see progress quickly as you knock out the smaller debts first.
The high rate method
The high rate method is also known as the "avalanche method" because it focuses on paying off the debts with the highest interest rates first. This can save you more money in the long run because you'll pay less in interest.
To use this method, you list your debts from the highest interest rate to the lowest interest rate. You pay as much as you can on the debt with the highest interest rate while making minimum payments on your other debts. Once the highest interest debt is paid off, you move on to the next highest, and so on.
Let's look at your debts again:
- A car loan with a balance of
- A credit card with a balance of
- A student loan with a balance of
Using the high rate method, you will arrange debts by the interest rate, biggest to smallest.
Using the high interest method, the order ends up like this:
| Interest rate | Type of loan | Balance |
|---|---|---|
| Credit card | ||
| Car loan | ||
| Student loan |
Using the same example as before, you would start by paying off the credit card with the
This method might take longer to see progress, but you'll save more money overall by paying less interest.
Which method is best for you?
Choosing between the snowball and high rate methods depends on your personality and what motivates you. If you feel encouraged by seeing quick progress, the snowball method might be best for you. On the other hand, if you're more focused on saving money in the long run, the high rate method might be a better choice.
Remember, the most important thing is to make a plan and stick to it. No matter which method you choose, being committed to paying off your debt will help you achieve financial freedom and enjoy the things you love without the burden of debt.
Want to join the conversation?
maybe pay off the lowest debt first if it will make you feel better to get something off of you, then resort back to the avalanche method.(24 votes)
If that works for you, then do it. Someone might counsel paying off the highest interest loans first to lessen the outflow of cash as quickly as possible, but I like your idea of giving yourself a treat, and paying off the thing that can be dealt with most quickly first, just to have a good feeling. You get my upvote!(12 votes)
- For the Avalanche method, isn't it best to pay off the car loan first instead of the credit card? I get that the credit card has the highest interest rate. However, %10 of $10000 is $1000, and 20% of $1000 (the credit card debt) is $200. Correct me if I'm wrong, but wouldn't it be better to prioritize the loans based on how much more money will we pay instead of just looking at the interest rates?(11 votes)
- You make a good point. Perhaps the thing to consider when you relate to interest is to consider it as "rent for money". Do you want to get your rent down, or do you want to get downsize the amount you are renting? Look at it that way first, and follow what makes the most sense to you.(3 votes)
- maybe pay off the lowest debt first if it will make you feel better to get something off of you, then resort back to the avalanche method.(5 votes)
- That splits the difference nicely. I like it.(2 votes)
Why use high rate save money?
Car loan should pay10%，so interesting should be 1000，that means car loan should be paid first(2 votes)- You're right! Pay off the high interest ones as soon as you can, and you'll be dollars ahead when you get to the end of ALL the debt.(5 votes)
- pretty good artical and good explanation(3 votes)
As the size of a Loan increases, the maximum APR, including fees, tends to decrease-From a median of 36.5% for a $500 five-year loan to 31% for a %2,000 two-year loan to 25% for a 10,000 five -year loan. Some states have no rate cap at all.Answer that David(3 votes)- The maximum rate for your loan is 9.99% if your term is 10 years or less. For loan terms of more than 10 years to 15 years, the interest rate will never exceed 9.95%.For loan terms over 15 years, the interest rate will never exceed 11.95%.So how come you said 650% of interest rate.(1 vote)
- If I borrow $1000 at 11.95% interest and make no payments on the loan for 15 years, letting the interest compound, then by the end of 15 years I will owe $5437, which is certainly not 650%, but is a LOT more than the $1000 I originally borrowed.(3 votes)
- the splits the difference nicely i like it(2 votes)
what if i want to save for a car in 2 years and it cost up to 6 thousand(2 votes)- Then divide 6,000 by 24 and set aside $250 per month until you have that amount. Don't neglect to set aside additional money to register and insure the car though.(2 votes)
I had a huge reflection on this:
This is similar to how we choose to do stuff on our "to do tasks": doing things that is most important first (which is most optimal) VS do things that are easier first (stacking small Ws at a time)
So if we remove the feeler in us, doing things in priority will give best result, but because of motivation and feelings, sometimes we do stuff that is not as important but it’s easier and help keep us motivated‒
I remember the seasons that I was winning in life and I was prioritizing things that I have to do and I felt like I was on top of everything I have to do and winning in every aspect of my life and I have so much time to enjoy later.
Lately, I feel like I have to do so much routines or so much less important (but easier task) to start up my day or to get myself motivated‒ and sometimes I don’t even get to cross of the most important things I plan to do for the day.
Thank you so much for this lesson! And I wanted to share this incase somebody else will find it helpful, too.(2 votes)