You’ve made the decision to get rid of debt, and you're 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, including student loans.
Should you use the snowball method or avalanche method?
What about the debt snowflake method? And before you go looking that one up, no, it's not a legit debt payoff strategy!
Instead of getting hung up on different payoff methods, 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 your account statements and order a copy of your credit report. Check the National Student Loan Data System for your Federal Student Loan debt obligations and their associated servicers.
Make note of the following for each obligation:
- Current outstanding balance
- Status of the debt (payment satisfied to-date, in deferment, delinquent, etc.)
- Type of interest rate (fixed or variable)
- Annual interest rate
- Minimum monthly payment requirements
With this information, you will get a clear picture of your total debt and the monthly minimum payments 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. Calculate this on a daily basis and for the frequency at which it is billed.
For a $10,000 student loan at a fixed annual interest rate of 10%, that's 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. This amount can be added to the principal balance if it’s not paid before the deferment period ends, through 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 you decide which debt payoff strategy 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. Then, throw as many extra payments toward 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 most costly debt, and tackle it. Then, repeat the process until your debt is gone.
Other things to consider
This 3-step guide is the perfect way to start 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.
In addition, 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 becoming debt free, to switch the methods available to you on the way. Most of all, use each win from paying off a debt to get you to the other side!