Let Me Clarify
There is more than one way to cook an egg (yes, I purposely chose to bypass the more commonly known phrase about a cat’s demise). Personal finance also reminds us that there is no one single cookie-cutter way to approach things. Aside from investing, how much you should be saving, and when to retire, one of the most common topics around this concept is how to pay down debt.
Let me clarify.
Much like other areas of financial planning, facts and numbers can paint a pretty picture of the future. However, often forgotten is how much more important human emotion and decision making are when it comes to achieving your financial goals. One path might be best in theory, but that does not mean that everybody has faith in it or can stick with it when times get tough. At the same time, it seems that life changes just about every minute of every day. And what is best based on the facts of today will not always be best based on the facts of tomorrow.
You may have heard of “snowballing” or “avalanching” payments, relating to paying down debt. This is the go-to method for efficiency in ridding yourself of the debt burden on your shoulders, but I often see individuals abandon this plan when immediate/shorter-term progress is not as visible.
What is the “avalanching” method?
Like student loans, it begins with getting organized and identifying what the situation really looks like.
- Step 1: Create a list of all debts/liabilities that you have, including balances, minimum monthly payment requirements, the monthly amounts you are actually paying, and the interest rates.
- Step 2: Order these items from highest to lowest interest rate.
- Step 3: Determine if you are currently paying more than the minimum amounts and if you have any additional cash flow that you would like to use toward paying down debt.
- Step 4: Apply all extra funds to the monthly payments with the highest interest rate.
- Step 5: Once this item is paid off, apply all extra funds (including what was being paid on the above debt) toward the next highest debt item on the list.
- Step 6: Continue this process down the list until all debt is paid off.
This may not seem groundbreaking, but you would be surprised by the amount of money and years of payments that I have seen saved through using this process of eliminating your highest interest debts first.
Why doesn’t everybody do this?
Again, there is a huge difference between human nature and what we see on paper. Sometimes it may take a few years for the first debt item to be completely paid off and some people tend to lose steam early on without seeing debt being eliminated in the short-term.
Is there an alternative?
For those that might struggle with or abandon the approach above, “snowballing” is worth considering.
The only difference between this and “avalanching” is that the debt items are ordered by balance amount (smallest to largest), instead of by interest rates. In comparison, this is not quite as efficient as the method above when it comes to how much interest you end up paying over the life of your loans. However, it does result in seeing those smaller debt items fall off your plate sooner than it otherwise would; potentially making it easier to see “progress” and not stray from the plan.
While I advocate for using the “avalanching” method (which is most efficient when comparing these options), I recognize that every client I speak with is different. I have to tailor the conversation to what gives each person the best chance at creating a plan that he or she will stick with…ultimately giving him or her the best chance of achieving their goals. At the end of the day, some action is better than no action.
It is ideal to have a structured plan in place, but remember that any additional payments (regardless of the interest rate, balance amount, or how often you pay extra) are better than not doing anything. They say that every journey begins with the first step; and paying down debt is no different. Small decisions here and there can have a profound impact in the long term.
If it is difficult to get that ball rolling, let us know, and maybe we can help give you that extra push that you need.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.