How to Craft Your Debt Pay Off Strategy in 3 Simple Steps
You’ve made the decision to get rid of debt, and you are ready to fully commit to team #debtfree. But creating a solid debt payoff strategy can be a challenge. This is especially true if you have a mix of revolving and installment debt, that might also include a medley of student loans.
Should you use the snowball method or avalanche method?
What about the debt snowflake method?
Instead of getting hung up on different payoff methods, and risk stalling your progress, use these three simple steps to craft your debt payoff strategy.
1. Write down all your debts
With the myriad of ways you can get into debt, it’s no surprise that you might not actually know exactly what type or how much of each debt you owe. Track you’re your account statements, order a copy of your credit report and check the National Student Loan Data System for your Federal Student Loan debt obligations and their associated servicers.
For each obligation, make note of the current outstanding balance, the status of the debt (payment satisfied to-date, in deferment, delinquent, etc.), the type of interest rate (fixed or variable), the annual interest rate and minimum monthly payment requirements.
With this information, you will get a clear picture of your total debt and the monthly minimum payments that you need to include in your baseline budget.
You need to get a clear picture of your total debt
and the monthly minimum payments that you need
to include in your baseline budget.
2. Calculate the daily cost of your debts
The annual interest rate on your debts only tells part of the story when it comes to the cost of your debt. For every debt you have, you should have a firm understanding of how the interest builds up on the outstanding balance, on a daily basis and frequency at which it is billed.
For a $10,000 student loan at a fixed annual interest rate of 10%, that is in deferment for 180 days, for example, the daily interest that accrues is $2.74. By the end of a 180-day period, the interest will amount to $493.15 and can be added to the principal balance if it’s not paid before the deferment period ends, though the process of capitalization.
Revolving debts, like credit cards and lines of credit, have their own interest accrual and capitalization rules. Review your loan promissory notes, and the agreements associated with your credit card and other debts, to confirm the applicable terms and conditions, and under what circumstances accrued interest can be capitalized.
Understanding these costs will also help your account for which debt payoff method will get you out of debt faster.
3. Choose one priority debt to start
Once you have budgeted for your minimum debt payments, and you fully understand how the daily interest costs on those debts work, choose one priority debt to start making extra payments on. Do this by identifying the debt that annoys you the most and throws as many extra payments towards it, as often as possible, until it’s paid off.
After that first debt payoff win, review your remaining debts and consider the next most annoying or the most costly debt, and tackle. Then, repeat the process keep going until the debt is all gone.
Other things to consider
This 3-step guide is the perfect way to get started on your debt payoff journey. Along the way though, always aim to cover the interest that builds up on your debt on a monthly basis, even if your lender doesn’t require it.
The next thing is, don’t ignore how delaying the payoff of debt with higher interest and higher principal balances can impact the length of your payoff.
With that said, be flexible enough on your journey to debt free, to switch the methods available to you on the way. And, most of all use each wins from paying off a debt to get you to the other side!
Melisa Boutin a personal finance expert passionate about helping millennials in the U.S. and the Caribbean and the founder of YourMoneyWorth.com.