You need to pay off some debt, but you’re not sure where to start. There are so many different opinions out there about how to get started. Here are some of the most popular ways, and how they work.
The Debt Snowball Method
The debt snowball was made up by the popular T.V. and radio personality, Dave Ramsey. It focuses on paying down debts according to the size of the debt. Of course, if you visualize a snowball, it’s easy to see how the method gets its name.
Starting with the smallest debt, you put as much money against that debt as possible. Then, when that debt is paid off, you take the old payment and apply it to the next largest debt. From there, you keep paying off debts, moving to the next largest debt.
The “snowball” keeps growing until all your debts are paid off.
This method works, but is more psychology than anything else. When you see those quick wins, you are motivated to keep going with it. But, don’t discount psychology. It can keep you from having to file bankruptcy.
The Debt Stack Method
This is the original method of paying down debt. It allows you to get out of debt by paying the least amount of interest. First, make a list of all your debts. For example, you may have debts that look like this:
Credit Card – $2,500 – 17% Interest
Visa – $7,500 – 12% Interest
Vehicle Loan – $4,000 – 10% Interest
Student Loan – $10,000 – 3% Interest
Once you’ve laid out all your debts, you arrange your payments so you pay extra to the debt with the highest interest rate. In this case, that’s the credit card with 17% interest. Any surplus funds go to this credit card. When the card is paid off, you move on to the next most expensive debt and so on until all your debts are paid off.
The Half-Payment Method
The half-payment method takes advantage of the disparity between pay periods and when your debt payments are due. Let’s say you get paid every 2 weeks, and you get $2,000. Every month you pay off your mortgage, which costs $2,000.
The half payment method says you should pay half your mortgage payment into an account with the first pay period. Then, with the second pay period, you pay the rest of it and then apply it to the mortgage.
So, with the first pay period, you receive $2,000. You set aside $1,000, which is half the payment. The money left over is set aside to pay for other bills or act as a cushion for other expenses. The next pay period, you set aside the rest of your mortgage payment and make the payment to the bank.
This helps you better manage your cash flow and makes it less likely you’ll bounce a check between debt payments.
The reason people use this method is because it means you can be better prepared for expenses that come up but that aren’t normal monthly expenses. And, you’ll rarely (if ever) get caught without money in your bank account.