How to Pay Down Your Debts
Whether you acquired debt from credit cards, a car, student loans or a mortgage, you’re likely to have borrowed money at one point in your life. These debts can eventually reach a point where you’re overwhelmed at the thought of paying them back. According to Nerd Wallet, in 2020 the average American household owed over $7,000 in credit card debt and over $56,000 in student loan debt. Managing your debt effectively will allow you to pay down the money you owe, without gaining more interest. There are some common methods for paying off your debts like debt snowball and debt avalanche.
To emulate these approaches, we will use this example for each:
You have four different types of debt you want to pay off. A Visa credit card with $1,000 owed at 12%, a student loan debt of $20,000 at 2% interest, a Banana Republic credit card with $2,000 debt at 26% interest and a mortgage of $300,000 at 5% interest.
Debt Avalanche is to pay off multiple loans based on their interest rates. Since you are paying down interest rates instead of the amount of debt owed, it can be a while before you have your first big success. However, in the end you’ll save more money because you won’t pay high interest on the initial capital you borrowed.
Using the debt avalanche method within our example, you would try to pay off your Banana Republic debt first while still paying the minimum amounts due on your other debts. Once you’ve eliminated that debt, you would focus on paying off your Visa credit card debt, then your mortgage and lastly, your student loan.
Debt Snowball is paying down multiple debts based on your smallest debts first. This method can be a good option for those who need encouragement when it comes to achieving goals. Because you are tackling the debt by the amount owed instead of interest rates, your first win will arrive much faster than with the debt avalanche method. Once you have eliminated all other debts, and only have your largest one left outstanding, you can reallocate the funds you would have put toward your other monthly debts and pay off your last one faster.
In our example, you would pay off your Visa credit card debt first and then move on to focus on your Banana Republic debt, followed by your student loan debt and then your mortgage. In the end, you could use what you would have paid each month for your Visa, Banana Republic and student loan debt, and put it toward your mortgage to pay it off faster.
Debt Consolidation and Management Plan
Debt consolidation and debt management plans are not ways to attack your debt, but rather tools to think about your debt. Consider if you could consolidate all your debts into one place at a lower interest rate; you wouldn’t have to worry about money amounts or different interest rates. However, it is crucial to be aware of scams. In 2018, debt consolidation scams were the number one complaint with the Federal Trade Commission.
If you’re looking for help with credit card debt, consider using a credit counseling agency to develop a debt management plan. These programs can help you with lower interest rates and pay your debt faster. However, they are best for those specifically with credit card debt. These programs cannot assist with student loan debt or medical bills.
In the end, you’ll need to decide which method is suitable for your lifestyle. Choosing one over the other doesn’t matter as long as it helps you pay off your debts.
If you are considering a mortgage, but aren’t sure how to calculate your debts, talk with one of our Loan Advisors today.