As there are many strategies out there, they all are correct - as long as you decide which works best for you and which one you are going to follow through with. So I’m going to explain some of the more common methods to have an idea of what options you have. Keep in mind that these can be used for both personal and/or business debts. Before you’re even able to determine which method is right for you, you’ll need to make a list of all debts and include the minimum payment (even if you’ve been paying more), the interest rate, current balance and total # months left to pay (if known). Now that you have that ready, let’s look to see what options we may have:
Debt Snowball - this is the most common one that you’ve probably heard of. This is when you list all of your debts in order from smallest balance to largest (no matter the other factors such as minimums or interest rates). You pay the minimum amount on all debts. However, when you have extra money to pay towards your debt, it gets thrown at the one at the top of this list (the smallest balance). Many times this helps you get motivated to continue with your strategy to pay off debt because it’s a quick win, especially if you have a small dollar amount that you end up paying off in a month or two. This will then keep you motivated to move onto the next smallest balanced debt. Not only will you continue to pay minimums on everything, but you’ll also add the minimum payment of the debt you just paid off onto the minimum payment of the 2nd debt, and so forth. This continues until you have paid off your debts.
Debt Avalance - while the debt snowball focuses on the current balance, the debt avalanche looks at the highest interest rate. You may have credit cards in the teens or even twenty’s in interest that are charging a lot in the long run (financially speaking). With this method, you list your debts highest interest rate to lowest and pay off in that order. Even though you’re using this method to help save money, you’ll still follow the steps of the debt snowball after you’ve paid off the first debt (rolling the minimum payment towards the next debt, etc).
I’m going to introduce another strategy for you to ponder as it may work better for you, especially if you are a business owner. Cash flow is very important. So another option is to list all your debts in the order of how many months are left to pay it off from lowest to highest. If you don’t know the answer, take the current balance and divide it by the minimum payment and enter that number. I know, you’re probably thinking what about the interest I’m being charged. While that is a factor in how much you’ll pay in the long run, this is a simple way to build more cash flow quicker (again depending on your numbers). As you pay off the first debt, that minimum payment you were spending still goes to the next debt, but may be more than if you started with the smallest balanced debt or the one with the highest interest rate.
Another way to keep your debt from increasing is to stop going into debt! If you feel like you’re in a rut and can never get out, you need to focus on your plan to pay it off, not add more debt to take care of the current situation. Now there may be a time that debt is okay, but if you’re reading to figure out for yourself how you need to take control, you’re probably not there yet. I went 4 years without a credit card so that I can build the habit of using my debit card if I wanted to buy something. While I now have credit cards, I use them responsibly (and that’s for another blog post). Sometimes life happens and you have a need that costs money (such as a car). There are always exceptions to the rule as long as you are responsible about those decisions and include your financial coach with the decision (if I had a coach when I made some of these purchases, it would have saved me a buttload lol). Also, keep in mind that the method you choose may change down the road as it may make more sense to you based on your situation. Not sure what will work best for you? That’s what I’m here for! Let me help you create your game plan to take control of your finances including the debt(s).
And one more thing… as you pay down your credit cards, the minimum due will decrease. Do NOT decrease that payment even if it’s not next on your list to pay off. If when you start this journey, your minimum payment is $47, then it’s always $47 until you pay it off.