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Wednesday, December 1, 2010 |

Is There a “Best Method” to Paying Off Debt?

There are a lot of “experts” out there giving advice on what to do with your money, especially when it comes to getting rid of debt.You might hear these people claiming the snowball method works best, or that paying off the highest rate is the most economical, or that consolidation is the only way.I’ve heard a lot about the pros and cons for each of these methods, but in my experience, I don’t think one is better than the other. What works for Jane Smith may be the worst method for John Doe. So the question becomes: Which method works for you?

Debt Snowball
The debt snowball method involves making a list of all your debts in order of their balance. The goal is to pay off the loan/credit card with the smallest balance first. Then, once that one is paid off, you put all that money towards the next smallest balance. You continue to do this until you’ve paid everything off. This one has a lot of psychological benefits, but it may not make the most economical sense. Because you are paying off the smallest balance first, you are seeing results quicker. Similar to crossing off items on a to-do list, there is a sense of joy in paying off certain loans or credit cards. However, with this method, you may pay more in interest in the long run. This occurs because you are not taking interest rates on your loans or credit cards into account. For myself, this is a very attractive method because I am the type of person that loves to cross items off a to-do list.

Highest Rate
This method is somewhat similar to the snowball method, but makes more economical sense. In this method, you list all your debts in order of their interest rates, highest to lowest. Then, you pay as much toward the debt with the highest interest rate until it is paid off. Then you take all that money and start to pay down the balance with the second highest rate. You continue this until all your debts have been paid off.

This method will keep you from paying extra interest as you’re working to be debt free. However, the debt with the highest rate could have a large or even the largest balance, which might make it hard to pay off quickly. If you’re someone who likes to see results quickly to stay motivated, this might not be the best method.

For myself, I like to see results quickly because it keeps me motivated to continue, so this method may not be the best.

Consolidation
This method is simple to understand, but may not be the easiest to achieve since it requires taking out additional debt. Consolidation requires combining all your debt into one account and one payment. The major benefit of consolidation is that you are only making one payment a month, rather than multiple payments to different merchants. Another benefit is that your consolidated payment might be less than the total of all the payments you were making before. This can be beneficial especially if you’re struggling to make all your payments each month.

It’s important to note that there are different ways to consolidate your bills. In this post, I’m talking about consolidation loans you take out on your own, such as a home equity loan or balance transfer or line of credit. I am not talking about those done through a third party “debt-consolidation” company. These can be dangerous to your wallet and to your credit score.

There are other methods out there, each with their pros and cons. To figure out which one works for you, you’ll need to look at each and see which one fits you best.

What methods have worked for you? Why?

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