The average American has a personal debt balance of $92,727, according to a 2020 Consumer Credit Review conducted by Experian. Whether your debt is a result of a credit card balance, student loans, mortgage, medical expenses or something else, it’s a burden that the majority of American’s struggle to deal with everyday. This article will provide you with the best strategies, tools, tips and tricks to expeditiously cut down your debt and set you up to live debt-free.
Debt Snowball And Debt Avalanche Strategy
Out of all the debt reduction strategies discussed in this article, the debt snowball and debt avalanche methods are some of the most common and effective ways to tackle debt. Each of these techniques has pros and cons, and one may be better than the other depending on your financial situation.
Debt Snowball
The debt snowball method takes the approach of paying your debts from the smallest balance to the largest. To accomplish this strategy, you need to:
- Organize all of your debt from the smallest balance to the biggest (no matter the interest rate)
- Make the minimum payment on all of your accounts, excluding the smallest balance
- Pay as much as possible toward the account with the smallest balance
- Once you have paid off the smallest balance, you can repeat this approach toward your next account and continue doing so until all debts are paid in full.
Here is a simplified example of how to use the snowball method:
| Types of Debit | Account Balance | Interest Rate: |
|---|---|---|
| Car Loan | $10,000 | 3.0% |
| Credit Card | $12,500 | 22.99% (APR) |
| Student Loan | $16,000 | 4.5% |
For this example, if you were using the snowball method, you would make the minimum payments on the credit card and student loan while putting as much money as possible into the car loan.
There are few drawbacks to this method. Overall the debt becomes more expensive because the interest will still be accruing. Since interest rate would not be the main factor when using this strategy, it can take longer to become debt-free.
However, implementing this method has more to do with the psychological impact than it does with math. It’s easy to use, and you gain confidence by paying off an entire balance. By knocking off different loans, you start to build up momentum and speed, leading into the final outstanding debt, hence the snowball effect.
Debt Avalanche
Unlike the snowball method, the debt avalanche strategy focuses on paying off the account with the highest interest rate. To accomplish this strategy, you need to:
- Organize all of your debt from highest interest rate to lowest
- Make the minimum payment on all of your accounts, excluding the account with the highest interest rate
- Pay as much as possible toward the account with the highest interest rate
- Once you have paid off the account with the highest interest rate, you can repeat this approach toward your next account and continue doing so until all debts are paid in full.
Using the previous example here is how to use the avalanche method:
| Type of Debit | Account Balance | Interest Rate: |
|---|---|---|
| Credit Card | $12,000 | 22.99% (APR) |
| Student Loan | $16,000 | 4.5% |
| Car Loan | $10,000 | 3.0% |
Using the avalanche method, the order of importance would be adjusted. Since the student loan has a higher interest rate than the car loan, you would want to tackle the student loan after the credit card balance has been paid off.
Similar to the snowball method, the avalanche strategy has some benefits and drawbacks. The benefits include minimizing the amount of interest paid, and the time to crawl out of debt increases significantly. Additionally, you’ll receive some gratification from knocking off the highest interest account. However, the drawbacks may divert some people away from taking this approach. This method typically requires a constant amount of discretionary income, and it does generally take longer to see the overall progress.
Debt Consolidation
Debt consolidation is another effective way to pay off debt. There are two main ways to consolidate your debt—both of which will put your debt into one monthly payment.
Paying off Debt With a Balance Transfer
Credit card debt is one of the most popular forms of debt in America. According to Experian, 75% of credit card carriers have a balance greater than $0, and the average balance held was $5,315 in Q3 2020. If you are drowning in credit card debt, a balance transfer may be one strategy you want to pursue.
A balance transfer is where you move your current credit card debt to another card that comes with a lower interest rate, or in some instances, a card with a 0% introductory APR. You must first apply for a balance transfer credit card. If you have a “good” or “excellent” credit score, you’ll typically qualify for the best offers. It’s recommended to shop around to find the best deal available.
While a balance transfer is an excellent way to pay off credit card debt quickly, a couple of stipulations come with this strategy. You may have to pay a transfer fee which is generally 3%-5% of the total balance transferred. Also, a balance transfer may take up to two weeks once initiated. During this period, you’ll still have to make payments on your current card.
By implementing this strategy, you’ll be able to pay more of the principal amount and quickly pay off your credit card debt. If this is a strategy you wish to pursue, Arizona Central Credit Union offers a balance transfer calculator to formulate an efficient repayment plan.
Applying for a Debt Consolidation Loan
A debt consolidation loan is a personal loan used to pay off multiple overwhelming debts. This can include credit card debt, medical bills and much more. A debt consolidation loan’s goal is to transfer the account balances from your debts into a single loan with a single monthly payment and generally a lower overall interest rate. Similar to applying for a balance transfer, you’ll want to shop around to find the best opportunity available to your situation.
Suppose this is a strategy you wish to pursue. In that case, Arizona Central Credit Union offers a debt consolidation calculator to help formulate an efficient repayment plan and show you how much you’ll be saving.
Consider Filing For Bankruptcy
When your debt has become too much to handle, and you feel like there is no way out, filing for bankruptcy may be the only option for your situation. Filing for bankruptcy can offer you a clean slate financially. However, this option should only be considered when you have exhausted all other avenues. That’s because filing for bankruptcy can negatively impact your credit score.
There are two types of personal bankruptcy—Chapter 7 and Chapter 13. According to a website maintained by the Administrative Office of the U.S. Courts, Chapter 7 bankruptcy may not wipe all debt away, and you may be required to forfeit some of your assets. Chapter 13 bankruptcy will allow you to keep your assets and file a 5-year repayment plan.
Bankruptcy is a long and potentially expensive process. As mentioned previously, it should only be considered as a last-ditch effort to clear any debt.
Seek Advice From The Experts
When debt starts piling up, it can feel like there is no way out. Implementing a payoff strategy will reassure you that there is light at the end of the tunnel.
Arizona Central Credit Union offers a range of financial services. Whether you have questions about debt payoff strategies, student loans, banking, home loans or any other financial-related questions—our financial experts can help. Contact us if you have questions or would like to open a bank account.
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