When you get to the point that you have your spending and budget under control so you are paying more than the minimum payments on your debts and have a plan on how long it will take you to pay them off, doing whatever you can to accelerate the debt elimination process will get you to the place of being debt free faster which is the first step in creating a solid financial foundation.

Having a plan on how you’ll pay off your debts is important, just like having a plan for budgeting your finances. Usually the best thing to do is to choose one of your debts to pay off first and pay the minimum on all of the others. Once the first debt is completely paid off, you would take the money you were putting toward paying that debt off and apply it to the next one you want to pay off. There are different methods you could use in deciding what order you want to pay off your debts. The two most common methods are the Snowball Method and the Avalanche Method.

Snowball Method of Paying off Debts

With the Snowball method of paying off your debts, you would choose the debt with the smallest balance to pay off first. The advantage of this is that it is probably the one that you’ll be able to pay off the fastest and psychologically, seeing an individual debt balance paid off can be motivating to keep you going with the process of getting them all paid off. Here is an example of how this works.

Say you have the following debts:

• Credit card balance of $4,000 with an interest rate of 18% and a minimum payment of $100 per month
• Credit card balance of $6,000 with an interest rate of 24% and a minimum payment of $180 per month
• Student Loan balance of $10,000 with an interest rate of 6.8% and a monthly payment amount of $115
• Car loan balance of $8,000 with an interest rate of 5% and a monthly payment amount of $189

So in this scenario the minimum payments on your debts would be $584 per month. If you had a plan to be able to put $1,000 a month toward your debts, with the Snowball Method, you would pay the minimum payments on all the debts except the credit card debt with the $4,000 balance since this is the smallest balance and would get paid off the fastest. Doing this, you would have that first credit card paid off in 9 months. Once that card is paid off, you would apply the payment you were paying toward the first card to paying down the 2nd credit card since that is the next lowest balance until that one is paid off. Then you would focus on the car loan and finally the student loan. The nice thing is that as you pay off each debt, the amount you’re able to apply to the next loan grows because you have fewer loans you’re paying on.

Avalanche Method of Paying Off Debts

The difference with the Avalanche Method is instead of choosing the debt with the lowest balance to pay off first, you would pay the highest interest rate first. Using this same scenario, you would pay the minimums on all of the debts except the credit card debt with the 24% interest rate since that is the debt with the highest rate. Once that is paid, you would focus on the next credit card, then the student loan and the car loan last since it has the lowest interest rate.

Which Method Should I Use?

It’s up to you which method you choose. Depending on what your debt list looks like, you may choose to use the Snowball Method to get some of your smaller debts knocked out quickly to reduce the number of debts you’re having to manage.

Just looking at the numbers, you would pay off the debts faster using the Avalanche Method. How much faster will depend on how much debt you have and how big of a difference there is in the interest rates of your different debts. If you have debts with widely varying interest rates, it may make sense to pay off the highest interest debts first as they are accruing the most interest.

What Can I Do to Accelerate the Process of Paying Off Debt?

As we talked about in the process of creating your budget, there are some things you can do to speed up the pace on paying off your debt. The two main things to focus on are cutting your spending as much as you can to have more money to put toward paying off your debt and to make extra income from either working extra hours or taking on a part time job in addition to your regular job to possibly seeing if there are things that you could maybe sell that you don’t need or use. All of this extra money can be used to pay the debt off faster.

What Are the Advantages to Being Debt Free?

You may wonder what advantage there is to being out of debt. After all, isn’t having debt a normal way of life for most people? The answer to this question is yes, most people have debt in some form. There are definitely advantages to being debt free though.

Probably the biggest advantage is you are free from the monthly payments you have to make on the debts that you owe. Being debt free provides a sense of freedom. The book of Proverbs in the Bible states this well. Proverbs 22:7 tells us that “the borrower is servant to the lender”. You may have never looked at it this way before, but when you owe someone money whether it be a credit card company, a bank or your home mortgage company, you are obligated to pay that money back. So until the debt is paid off, you have an obligation to them to pay each month until the balance is paid. Once you start paying the debts off, you may be surprised what a freeing feeling it is each time an individual debt is paid. And when you get to the place of paying the last debt off, the feeling is like removing a weight off your back.

Another advantage of being debt free is that you aren’t paying interest on the debts. Borrowing money comes at a cost. For example, say you took out a student loan of $40,000 at an interest rate of 6% and took 10 years to pay the loan off. At the end of the 10 years, you would have paid $13,289.84 in interest alone. That’s an extra 33% added onto the money that you borrowed. I know there are advantages to college education in some cases, but if you could find a way to pay for school without having to borrow money, or borrowing as little as possible, it makes things much easier to manage once you’ve finished school.

Let’s talk about car payments. You might be thinking, “Everyone borrows money to buy a car”. It is true that most people take out a loan to purchase a car. Though there is a big difference in the percentage of people borrowing money for a new car compared to those purchasing a used car. About 80% of new car buyers will use some level of loan to help pay for their new vehicle as opposed to only about 40% for used car buyers. There is a way to at least eventually get to the point of not taking out a loan to purchase a vehicle. We’ll talk about this more in Stage 3.

Another big advantage to being debt free is that you have more freedom to making better choices with your financial decisions. Remember that each of our day to day choices on how we spend the money we have will affect things a long way into the future.

We can look at one simple example. I’m not a coffee drinker, but I know that most people are, and I know that Starbucks is probably the most popular branded coffee shop. If you’re someone who likes to get your daily coffee from somewhere like Starbucks, it isn’t difficult to spend $5 a day getting coffee from Starbucks or some other coffee shop. You might think $5 isn’t so much, until you look at the fact that it adds up to $150 a month or $1,800 a year. If you were to put that amount aside extra into your retirement account for 30 years and got an average 10% return on your investments, that $5 a day would mean an additional $309,426 for retirement after 30 years. If you’re only in your 20’s and you have 40 years until retirement, after 40 years it would amount to an additional $832,552 for your retirement account. If you were able to manage your money in a way that you could average a 12% return on your investments, that would mean the $5 a day would be worth $1,455,153 after 40 years. You just have to decide if the $5 coffee is worth the exchange or maybe making your coffee at home may be a better choice.