Last week I shared my journey paying off credit card debt, prior to the days of my personal finance wisdom :). Luckily I’d always had this discomfort with debt (particularly bad debt), which served as motivation to clear the balance and keep any debt to a minimum going forwards. I know that not everyone views debt this way. Some people happily use debt to fund things that they are unable to afford such as the designer clothes/shoes, tech gadgets and cars. Oftentimes debt is used as a method to tackle emergencies due to a lack of emergency funds. This is done under the assumption that income will continue indefinitely to cover these debts, which makes me think did the crash of 2008 and the associated job losses teach us nothing???
Today it remains normal to use credit to fill a gap in funds; it’s almost strange if you aren’t doing it. Nonetheless the reality remains that debt is a financial emergency – something we need to reduce/eliminate as soon as possible to take control of our financial situation. From mortgages to store/credit card debt, the sooner we can remove the debt burden the better!
“Bad debt is sacrificing your future day needs for your present day desires”
– Suze Orman
So what should you do if you are currently in debt? Draw up a plan to eliminate that debt as soon as possible. To assist I will be looking at two debt repayment methods in this post – Debt Avalanche and Debt Snowball.
Debt Avalanche
This method is the fastest and the cheapest way to repay debts. It involves:
- Listing your debts with the highest interest rate first
- Making minimum payments on all debts
- Whilst allocating the remainder of your repayment amount to the debt with the highest interest rate
- This is then repeated – once the debt with the highest interest has been cleared you then move on to the debt with the second highest interest rate and so on.
So let’s say you have the following debts and plan to make repayments of £1,000 per month:
- Credit card 1 – £1,000 at 15.9% interest
- Store Card – £5,000 at 20% interest
- Credit card 2 – £10,000 at 18% interest
You would rank them in the following order – store card, credit card 2 then credit card 1. To begin with you would only make minimum repayments to the credit cards with the remainder of your repayment allocation going to the store card. Once the balance on the store card has been cleared, you would then continue to make minimum payments to credit card 1 whilst focusing the bulk of your repayment on credit card 2 (due to its higher interest rate).
Using the Avalanche Method, these debts would be cleared by April 2019, with total interest paid coming to £6,854.
Debt Snowball
Now the Snowball method involves tackling your debt starting with the smallest balance first. Although not necessarily the fastest or the cheapest way to clear your debt, this approach, as championed by Finance Guru Dave Ramsey, serves to give you a motivational boost as you eliminate your debt balances one by one. By starting with the smallest balance first, the view is that you will clear one whole debt balance in a shorter period of time, thus spurring you on to clear other outstanding balances.
For the example above debts would be repaid in the following order – credit card 1 (balance £1,000), store card (£5,000), credit card 2 (£10,000). Using this method repayment would be completed in May 2019 (one month later), with total interest paid of £7,173 (£319 more paid). This highlights the main disadvantages to this method – it can take longer to pay off all your debts and you can end up paying substantially more in the process.
Do you have some debts you want to tackle?
Run your numbers through this calculator to find out which of the repayment methods works best for your situation. To calculate using the Avalanche approach select “Interest order”. Alternatively to calculate using the Snowball method select “Balance Order”. Personally I prefer the Avalanche approach as it saves money and time, however there can be circumstances where the outcomes of the two methods don’t vary significantly.
Consider whether you prefer to break things down into small milestones or if your preference is to complete repayment as quickly and as cheaply as possible. Most important of all, remember it took time to get into debt so it will take time to get out of it. With commitment and consistency it’s possible, so don’t delay.
Have you used any of the above methods to tackle debt? What were the obstacles that you faced? How long did it take to clear the debt? Is there anything that you would do differently if you had the time again?
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