I’ve read a lot of personal finance books over the years. Some of what I have read has been excellent. Some of what I have read is just so-so. Through my reading and taking to others, I have noticed that there are really only a few different approaches to paying off debt.
The Debt Snowball
This method, made popular by financial guru Dave Ramsey suggests that you pay off your smallest debt first. Then tackle the next largest debt and so on until all your debts are paid off. The idea is that you build momentum with each debt that gets paid off. You gain confidence and earn more freedom with each debt paid.
Highest Interest First
From a mathematical standpoint it makes sense to pay off your debt with the highest interest rate first. Why? Because it is costing you more to keep that debt around than other debts with lesser interest rates. The downside to this is that if your highest rate debt happens to be your 30-year mortgage, it will take you a lifetime to pay off your debts. This approach is for those of you who don’t mind slogging through debt for a long, long time.
Pay it all in one chunk
If you are lucky enough to get a windfall of some sort (a big tax refund, an inheritance, prize winnings, etc), then you could just slap that new money onto your debt and call it good. But most people aren’t that lucky.
Other folks choose to invest their money and let it grow and then apply it to their debt. The argument in this case is that if invested properly, you could earn more money in interest than the interest on your debt is costing you. The drawback to this method: You have to be very good (or lucky) with your investments. If you aren’t, you’ll end up still in the hole.
You could consolidate all of your consumer debt into one large loan and pay it off that way. You’ll have the convenience of only having one debt payment to make each month. The downside is that there are a lot of scammy debt consolidation outfits out there and you have to be very careful that it doesn’t end up costing you even more money to do it. You could end up extending the length of your debt and/or pay higher interest rates than you would if you were to use the debt snowball approach instead. You definitely have to crunch the numbers before heading this route.
That’s right, one approach is to just simply not pay your debt, declare bankruptcy and start over. This is the worst method of handling your debt because you are not accepting responsibility for your spending. You’ll destroy your credit rating and make it nearly impossible to get decent interest rates on mortgages and car loans for a long, long time. In addition, something as serious as a bankruptcy on your credit report can mean you’ll pay more for things like insurance. And chances are, if you walk away without learning anything from the experience, you’ll be right back in the same situation someday.
Which approach to paying off debt is best?
The thing to remember about finances is that you don’t have to take just one of these approaches to paying off debt. You can use a combination of methods to reach your goal.
For us, the debt snowball approach worked the best. I loved feeling like we were making real progress every time we paid off a debt. With every payment we made, we felt more confident that we could make it out of debt. But that wasn’t our only approach to paying off debt. We also used any extra chunks of money we got to pay down those bills. A cash birthday gift from a relative, an income tax refund, or simply money earned from a garage sale, were all put towards that debt snowball. This combination allowed us to pay off $19,000 of debt in just one year.
It doesn’t matter how you pay off the debt, just as long as it gets paid. Once you’re free from the shackles of debt, you’ll see the lure of a new approach to debt: Don’t get into it!