Every positive step you take to improve your overall financial health, even the smallest of them, has the potential to make a remarkable impact on your life. However, one of the best and most impactful decisions you can make is to pay down your credit card debt.
Deciding to face your credit card debt head-on can be difficult as lines of credit are so readily available, and relying on credit often becomes a crutch for many. But just like all bad habits, it’s possible to break your habit of dependence on credit cards. From there, you can work on maintaining good financial habits.
Not knowing where to start or which debt to pay off first can be paralyzing, so we are here to give you a toolkit to get you off the ground. We will walk you through whether it is better to prioritize higher interest or higher balance cards and what payoff methods are available to you so you are set up for success as you start your journey to financial freedom!
Tackling Your Debt
Americans carry a lot of debt. It is so commonplace now in the states that it has almost become standard in the American way of life. The average American carries a debt balance of $92,727, which is a formidable number, to be sure. The average size of debt can often make it feel impossible to pay down.
When you are just starting to tackle your credit debt head-on, it can be incredibly intimidating, especially if you feel like you are drowning in debt. That is why it is crucial to approach it in bite-sized pieces rather than allowing yourself to become stuck on the overall total of your debt.
While you must continue making the minimum monthly payments on all your credit cards, it is the best strategy to focus on paying down one credit card at a time. The question then comes down to which card you ought to start with.
Higher Interest vs. Higher Balance
There are generally two schools of thought amongst personal finance experts regarding credit debt repayment strategy. The first is to pay off your highest interest cards first to save money on costly APRs, and the second is to pay off your smallest balance first to use momentum to increase motivation.
Each priority has its pros and cons. Paying off your low-balance credit cards first can eliminate entire accounts far quicker, giving you an immediate sense of relief that could have a positive psychological effect. On the other hand, paying off your highest interest credit cards to start could save you an exponential amount of money on increasing interest charges for the balances on those cards.
Choosing Your Debt Pay Off Strategy
Determining which debt payoff strategy is best, high interest or low balance first, depends entirely on the borrower’s individual needs and priorities. The names these two most common pay-off strategies are known by in the world of personal finance are the Debt Avalanche Method and the Debt Snowball Method.
The Debt Avalanche Method:
This method has you continue making the minimum payments on all your card balances while redirecting all of the remaining money you have designated for debt repayment to the credit card with the highest interest rate.
After that credit card balance is completely paid off, you move on to the card with the second-highest interest rate and so on and so forth until they are all paid off.
The Debt Snowball Method:
This method has you continue making the minimum payments on all your balances while putting the rest of the money you intend to use for paying your debt off towards the credit card with the lowest balance.
This approach would make it so that the first balance is completely paid off fairly quickly, after which you can move to the second smallest balance and so on and so forth until you are completely free of credit card debt.
How To Use The Debt Avalanche Method
One of the most enticing aspects of using the Debt Avalanche method of debt payoff is the possibility of saving hundreds of dollars in interest. The Debt Avalanche method also has the potential to decrease the time it takes you to pay off your debt, particularly if you have a considerable amount of debt that would accrue a significant amount of interest.
While it has many advantages, the debt avalanche takes a severe amount of discipline and consistency. Making this strategy quick-moving enough to feel like you are getting somewhere requires a reliable amount of discretionary income every month you can put towards that high-interest balance.
Prioritize Your Debt
The first step will be to gather all the various debts you wish to include in your debt repayment method. If you aim to rid yourself of your credit card debt, you can keep your focus there; however, if you are working towards complete financial freedom, you can include everything from your student loan debt and medical bills to your car loan and personal monthly installment loans.
Using your financial records and credit card statements, determine the APRs for each of your outstanding balances and rearrange the order of your list from highest interest rate to lowest interest rate.
Keep Making Payments
Figure out how much money you plan to put towards your monthly debt repayment. Continue making only the minimum payments on all the debts except the one at the top of your list with the highest interest rate. Then use whatever money you have leftover, after covering those minimums, to pay down your highest-interest debt.
Continue paying extra towards that high-interest debt while occasionally taking stock of whether you can increase the amount you set aside in your budget. Analyze where you might be able to cut down on excess expenses or ways you can save money to repurpose for debt repayment.
Keep going every month until that debt with the highest interest rate and first on your list is completely paid off. Once that debt has disappeared, those exorbitant interest charges will no longer be a concern.
Payoff Your Debt!
Since one credit card balance has been eliminated, you now have one less minimum monthly payment to make, one that was likely pretty high given the high APR, which means that the amount you can put towards your next debt every month is even more significant. As you go along, the money you can put towards the primary debt you are tackling will increase more and more so that each debt gets eliminated even faster than the last.
Additionally, as you progress, the interest rates will get lower and lower until you have taken care of all the debts that could have accumulated the most costly charges, saving you hundreds of dollars. Keep going until you’ve crossed off every single debt on your list!
How To Use The Debt Snowball Method
Rather than numbers, the debt snowball method relies heavily on the power of the mind. It utilizes our natural psychological response to crossing a finish line to compel us forward and keep us motivated. The debt snowball method highlights that sometimes the seeming insurmountability of debt is what stops us from tackling it is not necessarily the financial inability to do so.
This method is perfect for borrowers who struggle with motivation and discipline. Starting with lower balance debts, regardless of interest rate, allows for more instant gratification and can offer individuals who are typically tempted to throw in the towel a feeling of success and accomplishment.
However, when not accounting for interest rates, using the snowball method means that you could pay more money overall because of the accruement of interest.
Organize Your Debt
Similar to the avalanche method, the first thing you will want to do will be to compile all the debts you wish to include in your debt repayment plan, whether that be just your credit card balances or all of your debts.
Re-order them in a list from the debt with the smallest balance to the debt with the most significant balance without regard for the interest rate. After making your list, the credit card balances will start small and get higher the further down the list you go.
Prioritize Payments on Smaller Balances
Next, determine how much money you plan to allocate every month to pay off your debt. Make only the minimum payments for every one of your debts, then take whatever amount leftover of what you budgeted monthly and put it towards that first debt on your list with the smallest balance.
Keep paying on that low-balance debt every month, possibly even increasing the amount you pay if you feel inspired to do so until that first debt is completely paid off, and you can cross it off your list for good.
After succeeding in putting one of your debts behind you, this may give you the desire to adjust your budget further or cut down on unnecessary expenses to commit even more money to your debt repayment plan.
Continue To Pay Higher Balances
Now is the time to use the momentum you have got going after enjoying the success of defeating the first balance to attack the next smallest debt. Additionally, you have one less minimum payment to cover with one debt gone, so you have an added $50 or more to put towards that next debt you are eliminating.
The amount you can pay on the debt you are paying down will increase with every debt that gets crossed off, creating a snowball effect making even the most significant balances disappear more quickly. Rinse and repeat until it’s all gone!
Which Method Is Best for You?
There is no definitive cut-and-dry answer to say which method is better as it comes down to the individual needs and priorities of the borrower. If you pick a plan based solely on the math of aiming for the least overall cost, then the Debt avalanche method will be the obvious choice. However, if you are choosing your method from a more behavioral perspective to make the discipline aspect easier, the snowball method could be the better approach.
When determining which method will be most successful for you, it is essential to look at your strengths and weaknesses when it comes to your personal finances. If you struggle with committing to plans that require a lot of patience, then the snowball method might be right for you. Whereas if you are most concerned with the bottom line and saving as much money as possible, then the avalanche method is likely the best option for you.
Whichever strategy you choose, it is vital to remember that the most important aspects of a successful debt repayment plan are consistency and perseverance!
References:
Experian 2020 Credit Consumer Review
The Debt Avalanche Method: How It Works and When To Use It
The Debt Snowball Method: How It Works and How To Use It
