Saving money is the stepping stone to building long-term wealth. It also allows you to be prepared for unexpected expenses, major life events, and retirement. However, it is very difficult to save when you are in debt. Money that could be sitting in an emergency fund or a high-yield savings account accruing interest instead goes to paying off interest accrued on student loans, credit card bills, car payments, and other loans. The more debt you eliminate, the more you can afford to save.
Create a Buffer before Slaying Debt
Many personal finance experts recommend having $1,000 in a savings account before you start aggressively going after your debt. This creates a buffer in your finances should unforeseen expenses arise. As much as we want to pay off debt, it’s not very beneficial if we’ll have to apply for a personal loan or max out our credit cards the moment an emergency arrives.
Determine Your Budget for Debt Payoff
When you create a budget, you factor in your minimum monthly debt payments into your monthly expenses. Once you decide that you want to slay your debt, you need to revisit your budget and determine how much money you can put toward debt repayment beyond the minimums.
Debt Payoff Methods
Once you have your $1,000 saved, there are two approaches you can take to slay your debt. The first approach is the Debt Avalanche Method, which focuses on paying off debts with the highest interest rates first. The second approach is the Debt Snowball Method, which focuses on paying off the smallest amount of debt first and saving your largest debt for last. Depending on the method you choose, any extra money you find in your budget or receive through work bonuses, gifts, or tax refunds should go toward your debt with the highest interest rate or your debt with the lowest amount owed.
As you aggressively pay off one debt, all other debts should only receive their minimum payments. Once you pay off your first debt, you should add that old debt payment to the minimum payment amount of the next debt you want to pay off. Repeating this cycle will allow you to pay off the next debt more aggressively than the last.
Debt Avalanche versus Debt Snowball
The longer you take to pay off a debt, the more you will pay in interest. The benefit of the Debt Avalanche Method is that it will save you the most money, as it allows you to knock out your debts with the highest interest rates sooner rather than later. The downside is that you don’t get the gratification of seeing a small debt disappear quickly.
The Debt Snowball Method is great for those who need motivation when it comes to paying off several debts. While you may not save as much in interest, you will quickly shorten your list of creditors. The freedom you feel from paying off your first small debt will encourage you to pay off the next debt and so on.
There are calculators you can use for each method—Debt Avalanche and Debt Snowball. We recommend that you enter your non-mortgage debts into each and compare the payoff approaches. You should ultimately choose the method that you’re most likely to stick with.
Avoid using credit cards as you pay off debt. After paying off all your debt, you’ll have more money to add to your savings, and that can be used to cover those unexpected expenses you used to rely on credit cards for.
Depending on how much debt you have, paying it all off may take years, but the reward of financial freedom by living debt-free is well worth it.