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Dec

11

2020

Dig Out of Debt

Two Strategies for Digging Out of Debt

Carrying consumer debt can weigh heavily on the minds of anyone. It reduces freedom of choice and cost a ton of money in interest. Assuming a person has more than one debt to pay off, which method of debt repayment should be used? Below are two strategies to consider, both containing benefits and pitfalls. The key is to be honest and stick with it.

► The Snowball Method

  • Rank loans from the smallest balance to the largest balance. Keep in mind that credit card balances are loans too.
  • Pay above the minimum on the loan with the smallest balance. Pay the minimum balance on all other loans.
  • When the smallest debt is paid off, take everything that was being put toward the account and add it to the payment for the loan with the next lowest balance.
  • Repeat the process until all debts are paid off.

►The Avalanche Method

  • Rank loans from the highest interest rate to the lowest interest rate. Don’t forget to include any credit cards with balances on them.
  • Pay above the minimum balance on the loan with the highest interest rate. Pay the minimum balance on all other loans.
  • When the debt with the highest interest is paid off, take everything that was being put toward the account and add it to the payment for the loan with the next highest interest rate.
  • Repeat the process until all debts are paid off.

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It’s easy to spot both the snowball and avalanche methods are similar in that they have consumers focus on a particular account while paying the minimum on all other accounts. When one account is paid off, it redirects whatever money that was allocated for that account to the next one.

But when you do the math, the avalanche method usually will get you out of debt faster. That’s because you reduce the amount of interest you pay on the loan. For this reason, the bulk of money gurus tell consumers to attack high-interest accounts first.

But here’s the catch. For some individuals, it’s incredibly hard to stay motivated and stick to a debt repayment plan. With the avalanche strategy, it may take longer to gain a sense of accomplishment, especially if there are a lot of credit card debts, as they tend to carry higher interest rates. There’s some solid science behind this. Dopamine is a natural hormone that not only keeps people looking for new information and answers (motivation), but it also helps them feel happy. The brain releases dopamine in anticipation of reward. So in theory, having multiple zero balances to look forward to along the way can make it easier to stick to a debt repayment plan!

Ultimately, which technique you use is a personal decision. Just be honest about your situation and habits and pick the strategy with which you feel most comfortable.

This article was brought you by Balance, Viriva’s financial education partner.