Start the New Year with New Approaches to Old Debt
Start the new year with a plan to consolidate, manage, and eliminate debt. Making headway in lessening debt, or even paying it off completely, is one resolution that’s doable and advisable to keep!
First, thoroughly understand your expenses, primarily how much goes out. The simplest way is to methodically track every dollar spent, every day, and on what. This can be done on an Excel spreadsheet or with any number of software programs, and yes, it can be tedious. It means saving receipts or, if accustomed to using a debit card rather than cash, looking at your checking account daily. One thing is for sure: however you conduct transactions, it is eye-opening. For example, purchasing the cheapest item at Starbucks—a $3.00 cup of black coffee—once a day adds up to over $1,000 a year. That’s a lot of money for not much coffee!
The good news is that a clear and accurate big picture of one’s spending can be seen in just a few months. There will always be unexpected expenses, of course, and daily costs add up. Other expenses, such as rent, mortgage, insurance premiums, or utilities, are predictable, even falling due on the same days and in the same amounts, so it’s easy to project those out.
The key to paying down debt is to do it wisely, which means discipline and structure. At its most basic, that means paying on time and paying more than the minimum. Luckily, there are solutions and processes that make the admirable goal of paying off debt achievable by almost anyone.
Debt Consolidation Options
A debt consolidation loan is just that – a loan with the sole purpose of paying off accumulated debt. The advantage is that these types of loans generally offer lower interest rates than credit cards and, for qualified borrowers, are often relatively easy to obtain. In some cases, the lending institution may pay creditors directly, rather than issuing funds to the borrower. There is a scheduled monthly payment and a final payoff date, so the goal of debt repayment is clearly structured.
Many credit cards have a low or 0% interest rate balance transfer option, so transferring balances from older cards to a new one that offers this perk can be a way to save money, especially if the balance is paid before the end of the introductory period, typically 12 to 18 months. After that, interest rates skyrocket, and the borrower may be no better off than before.
A home equity loan or line of credit may be an option, too. A home equity loan provides a lump sum at a fixed rate, while an equity line of credit is an open line of credit with a variable interest rate for the homeowner to use as they will. Both are considered second mortgages on a home but, if the borrower’s credit score is strong and there is enough equity, it is a viable option for consolidating and paying debt.
Payment Strategies
If these options are not available, there are two simple strategies that are effective and appealing – the Snowball and the Avalanche methods. Neither one is better than the other, and they can be adapted as needed to meet each borrower’s debt situation and motivational drives.
The Snowball method is simply paying the smallest balance off first. Once that debt is paid, put the monthly payment used for that balance towards what is being paid on the next lowest balance. After that balance is paid, repeat. The amount paid to each subsequent debt rises, “snowballing” as it goes along. Some people find achieving zero balances relatively quickly both highly satisfying and very motivating.
The Avalanche method is paying debt with the highest interest rate or balance first. Then, as that balance is paid in full, add the monthly sum used for that balance to what was until now the second-highest balance, or loan with the second-highest interest rate. This is like the Snowball method in that respect. The advantage is that by focusing on the largest balances and highest interest rates, some money may be saved overall. Some people take great satisfaction in seeing a large, scary debt off their books, which makes them eager to continue.
Graphic From Wells Fargo
Snowball Method
- Organize debt, including totals owed, minimum monthly payments, and due dates.
- List debts from smallest to largest.
- Budget more than the minimum payment by determining how much extra can be paid toward the monthly minimum payment on the lowest debt, after paying the minimum on all the others.
- When the smallest debt is paid, put that monthly payment, plus the extra budgeted, toward the next-smallest debt.
Avalanche Method
- Organize debt, including totals owed, minimum monthly payments, and due dates.
- List debts from highest to lowest, or from the highest interest rate to lowest.
- Budget more than the minimum payment by determining how much extra can be paid toward the monthly minimum payment on the largest total or highest interest rate debt, after paying the minimum on all the others.
- When the largest and/or highest interest rate debt is paid, put that monthly payment, plus the extra budgeted, toward the next largest and/or highest interest rate debt.
And Obviously…
Do not incur new debt! As much as possible, pay with cash, and in accordance with carefully documented expenditures, due dates, and balances. Any credit card used should be paid in full. Accruing debt is all too easy and getting out of it can be tough, but with a carefully structured plan in place, it can be rewarding – in every sense of the word!
