Debt Avalanche Method
So next we have debt avalanche, which if you want to call it the mathematically correct way to pay down your debt. Because instead of focusing on smallest balance to largest in order to get that win, we're focusing on crushing that highest interest rate debt first, and moving down in terms of interest rates. And the reason it's called the mathematically correct way is because it means over the course of paying off your debt, you'll pay the least amount of money in interest. Now the problem is a lot of us are not actually motivated by hearing that. The idea of, "Oh, I don't have to pay as much interest" doesn't actually keep you going when it feels like it's taking absolutely forever to get that first win and pay off that first debt, which is why debt snowball works better for a lot of people. But hey, maybe you are a money nerd like myself, and completely motivated by the idea of paying the least amount of interest possible to financial institutions. So let's break down how this one wo...
rks. We're gonna use the exact same debts with Ben and Leslie. So starting out they've got, again, the three credit cards and the student loan. But now the APR really does matter. We're not so much focused on the balance as making sure that we're listing everything out from highest interest rate to lowest interest rate. Again, they're gonna go through the process of running their cash flow, evaluating how much extra they have per month to put towards their debts. Same scenario, they've got that 330 a month. So that extra $76 is now going to get tacked on to the Town Bank Credit Card, because it has the highest APR. And you'll see here, the next one's going to be a bit easier to pay off because it's only $700. It's gonna take them longer to pay off Town Bank Credit Card, which is why it can be a little demoralizing for folks when you first get started, but they're gonna save the most money, because they're paying off that highest interest rate debt. The exact same principles as debt snowball, you attack, you attack. Make sure you're still paying the minimums on everything else, and then once it's paid off, you roll down to the next debt. Tack the minimum payment you were paying onto the next monthly payment, and you keep going and avalanching to the point where you're putting your extra 330 a month towards your lowest interest rate debt. So the exact same strategy as debt snowball, except we're focusing on highest interest rates to lowest interest rates. And you avalanche it until it is gone. Now I'm gonna pause again here. Does anyone have any questions about these two very common forms of debt repayment?
A question that's come in from Kat Po-sey, and maybe it's just to reiterate. Again, why pick only one of the debts instead of spreading your extra money that you have over all of the debts?
So that's a great question to ask. The reason you are focusing the extra money on one particular debt as opposed to putting a little bit extra here, is because you're going to attack it more aggressively and pay it off faster. Because if you spread the love around, it doesn't focus your efforts in the same way. So the goal here is basically to laser focus on one and then roll down, and especially with debt avalanche, when you're trying to attack an interest rate, it's going to help you to aggressively pay down the highest interest rate first, because you're going to still end up paying the least amount in interest over the life of the loan. Now some people kind of hybrid this strategy and that's totally okay. You might kind of mix and match and do some lower interest rates, some higher interest rates with balances. You can kind of model it however you want. These are just really the purely mathematical way to do it and the purely psychological way to do it. But if you want to mix and match because that feels better for you, that's fine too. Yes?
So looking at this example, can you give me just like a rough estimate of how long this takes? We're looking at the numbers here and we see how much they have available in their cash flow and what their total debt was.
It's gonna take a few years for all of this. This is not a magic bullet solution, especially with a $10,000 student loan balance and only paying 330 a month. That's definitely gonna take years. Now also remember that I streamlined this. This balance would not still be $10, after you've still been making the minimum monthly payment. It would have been coming down over the course of years, so do keep that in mind. It's just for visual purposes, was easier to keep it the same. But it's gonna take a couple of years. Now you also have to think about the fact that over those years, you're probably gonna have opportunities to be earning more in different places. Maybe you pick up a side gig and that's all money you're throwing at your debt. So you're gonna be able to either make lump sum payments at different times to aggressively pay it off. Maybe you get a tax refund and that's something you put towards it. So there are ways certainly to get out of debt faster, but these are the tried and true methods to stay on task and actually get to your end date. And there are lots of great calculators online that you can find, debt repayment calculators. Plug that term into google or your favorite search engine and things will certainly come up. There are a bunch of options. And then you can get the firm deadlines of, "If I do this technique, "here's how long it's gonna take me."
So my question when I'm looking at all this is you're assuming people are not going into more debt as they're paying off their debt. So is this like they're on a cash diet for the four years that it takes to pay off all these debts? What's the situation there, Erin?
So in these scenarios, which are the very cut and dry versions, yes, we're assuming you're not amassing more debt. The hope is you are on a budget. Hopefully you've got a little bit of an emergency fund. You've got that thousand dollar emergency fund we referred to yesterday saved up so that if something goes wrong, you don't have to finance it on a credit card. Now things can go wrong, maybe something does happen and you do end up in more debt. And then you're just gonna plug that information into your debt repayment strategy and have to recalculate all of your information.
One of the worst parts of carrying debt is the shame it induces. Too many people feel embarrassment and guilt about their debt, as if they’ve failed in some profound way. But the facts are that the average American adult has $4,717 in credit card debt, and more than 44 million Americans hold nearly $1.5 trillion in student debt, so there’s no reason to feel burdened by this unfair stigma.
Instead, you need to focus on taking proactive measures to deal with your debt or prevent it from ever accruing. Erin Lowry will explain some of the complex aspects of credit card and student loan debt, help you get rid of that overwhelming fear that you’ll never conquer your debt, and show you how to create a plan of action to attack your debt head on.
In this class, you’ll learn how to:
- Design a strategy that either pays off your debt gradually or quickly.
- Use balance transfers to avoid high interest rates.
- Find loans that will help, not hurt, your bottom line.
- Understand the differences between federal and private student loans.
- Figure out if you’re eligible for student loan forgiveness.
- Get help from charities or loved ones if you’re really in trouble.