Debt sucks! You know that and I know that (although I wish I knew it sooner). But how do you go about getting rid of it? It can be overwhelming when you have $150,000+ in debt. Personally, we don’t really know where to start. We also don’t know how to keep the momentum going after we get started. So, we explored three different methods to paying off debt.
The debt snowball was created by debt counselor and radio host Dave Ramsey. With this method, you basically list all of your debts out in order from smallest to largest. You then keep making minimum payments on all of your debts but the smallest. You attack the smallest debt with all of the extra money that you have in order to get it paid off fast. Once you get it paid off, you then take all of the extra money and roll it over to the next smallest debt. In essence, you are making a “debt snowball” that keeps getting larger and larger after you pay debts off. For an example, let’s take a look at our debt (listed smallest to largest):
1) Best Buy Credit Card: $1,468.90
2) Personal Loan: $1,922.68
3) His Car Loan: $7,279.19
4) Her Car Loan: $8,673.10
5) Family Loan: $16,500
6) Her Student Loan: $48,763.88
7) His Student Loan: $66,070.88
So, for us, we would continue to pay the minimums on each debt but the Best Buy card. Once we get that paid off, we roll over everything we were paying on that each month into the next debt. That will continue until each debt is paid off.
Dave Ramsey argues that personal finance is 20% head knowledge and 80% behavior. So, he states that having these “quick wins” will help keep you motivated.
Highest Interest Debt First
Some people argue that Dave Ramsey is bad at math. After reading that post, I agree with the premise that it is better to pay the highest interest debt first. However, I do also agree with Ramsey that you need some sort of motivation. For example, let’s say that you have five debts: $2,000 on a 0% credit card, $2,000 on a 5% home equity loan, $6,000 on a 7% car loan, $6,000 on a 8% car loan, and $35,000 on a 29% credit card that is at the universal default rate. Common math says pay off the high interest credit card because you are losing A LOT of money. However, you would not pay off any of the debts fast. I think that we would get discouraged if we were in that position.
Now, let’s take a look at our situation. Here are our debts (listed from highest interest rate to lowest):
1) Personal Loan (10.9%): $1,922.68
2) His Car Loan (6.49%): $7,279.19
3) Her Car Loan (5.49%): $8,673.10
4) Her Student Loan (~5%): $48,763.88
5) His Student Loan (~5%): $66,070.88
6) Family Loan (0%): $16,500
7) Best Buy Credit Card (0%): $1,468.90
I’m not sure what the rule is, but the 0% Best Buy card will got up to something like 20% next year. I think that would mean we should move it up the list (the top?). Otherwise, the list doesn’t seem to bad to me. The only thing that bothers us is the family loan being toward the bottom. Our family member said it was alright to pay them whenever, but we feel that it needs to be ASAP. There is something about a family loan that just doesn’t sit right with us right now. It was something that we needed to do at the time (to avoid HARD financial times) but since we are able to pay now, it seems like the right thing to do.
The debt tsunami is a debt reduction method that focuses on paying off debt in order of emotional impact. We really like this approach mostly due to the fact that we have a family loan. In the previous two methods, the family loan was placed toward the bottom of the pack in terms of when it is to be paid off. That’s not acceptable to us in the point in our debt reduction phase.
If it were up to us, this is how we would pay off our debts (emotional impact):
1) Best Buy Credit Card: $1,468.90 (mostly due to the fact that it will go up to 20% next year)
2) Personal Loan: $1,922.68 (we want to pay this next because it’s not much and will be a small victory for us)
3) Family Loan: $16,500 (like I said before, we want to get this paid off fast)
4) His Car Loan: $7,279.19 (after getting the family loan out of the way, we feel it’s best to pay them off in order of highest interest rate)
5) Her Car Loan: $8,673.10
6) Her Student Loan: $48.763.88
7) His Student Loan: $66,070.88
After some consideration, we feel that the debt tsunami is our best option. It allows us to pay off our family loan sooner and then focus on some higher interest rate debts.
How are you paying off you debt? What method to you use and why?